PROSPECTUS
August 1, 1999
This Prospectus describes the shares of a family of institutional mutual funds
managed by LM Institutional Advisors, Inc.
LM INSTITUTIONAL FUND ADVISORS I
Western Asset Government Money Market Portfolio
Western Asset Money Market Portfolio
Western Asset Limited Duration Portfolio
Western Asset Intermediate Portfolio
Western Asset Intermediate Plus Portfolio
Western Asset Core Portfolio
Western Asset Core Plus Portfolio
Western Asset High Yield Portfolio
Western Asset Non-U.S. Fixed Income Portfolio
Western Asset Global Strategic Income Portfolio
Western Asset Enhanced Equity Portfolio
LM INSTITUTIONAL FUND ADVISORS II
LM Value Institutional Portfolio
LM Special Investment Institutional Portfolio
LM Total Return Institutional Portfolio
Brandywine Small Cap Value Portfolio
Batterymarch International Equity Portfolio
Batterymarch Emerging Markets Portfolio
These securities have not been approved or disapproved by the Securities and
Exchange Commission nor has the Securities and Exchange Commission passed upon
the accuracy or adequacy of this prospectus. Any representation to the contrary
is a criminal offense.
[LM INSTITUTIONAL LOGO APPEARS HERE]
Advisors Incorporated
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TABLE OF CONTENTS
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PROSPECTUS SUMMARY..................................................................................3
DESCRIPTION OF EACH PORTFOLIO, ITS INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES.........3
PRINCIPAL RISKS....................................................................................13
PERFORMANCE INFORMATION............................................................................18
FEES AND EXPENSES..................................................................................20
MANAGEMENT OF THE PORTFOLIOS ......................................................................27
PURCHASE OF SHARES ................................................................................30
DISTRIBUTION PLANS.................................................................................32
REDEMPTION OF SHARES...............................................................................32
EXCHANGE PRIVILEGE.................................................................................33
NET ASSET VALUE....................................................................................33
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS........................................................34
TAX INFORMATION....................................................................................35
FINANCIAL HIGHLIGHTS...............................................................................36
APPENDIX A -- PRIOR PERFORMANCE OF ADVISERS' OTHER ACCOUNTS........................................43
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PROSPECTUS SUMMARY
General
LM Institutional Fund Advisors I, Inc. ("LMIFA I") consists of the following
portfolios: Western Asset Government Money Market Portfolio, Western Asset Money
Market Portfolio, Western Asset Limited Duration Portfolio, Western Asset
Intermediate Portfolio, Western Asset Intermediate Plus Portfolio, Western Asset
Core Portfolio, Western Asset Core Plus Portfolio, Western Asset High Yield
Portfolio, Western Asset Non-U.S. Fixed Income Portfolio, Western Asset Global
Strategic Income Portfolio and Western Asset Enhanced Equity Portfolio.
LM Institutional Fund Advisors II, Inc. ("LMIFA II") consists of the following
portfolios: LM Value Institutional Portfolio, LM Special Investment
Institutional Portfolio, LM Total Return Institutional Portfolio, Brandywine
Small Cap Value Portfolio, Batterymarch International Equity Portfolio and
Batterymarch Emerging Markets Portfolio.
Manager and Advisers
LM Institutional Advisors, Inc. (the "Manager") serves as the investment manager
to each Portfolio. Legg Mason Fund Adviser, Inc. ("LMFA"), Brandywine Asset
Management, Inc. ("Brandywine"), Batterymarch Financial Management, Inc.
("Batterymarch"), Western Asset Management Company ("Western Asset") and Western
Asset Global Management Limited ("WAGM") serve as the investment advisers to the
various Portfolios as noted below. LMFA, Brandywine, Batterymarch, Western Asset
and WAGM are referred to as "Advisers."
DESCRIPTION OF EACH PORTFOLIO, ITS INVESTMENT OBJECTIVE AND
PRINCIPAL INVESTMENT STRATEGIES
The investment objective and policies for each Portfolio are stated below.
WESTERN ASSET GOVERNMENT MONEY MARKET PORTFOLIO
Adviser: Western Asset
Objective: High current income consistent with liquidity and
conservation of principal
The Portfolio is a money market fund that seeks to maintain a net asset value of
$1.00 per share by investing in government money market instruments. To achieve
its objective, the Portfolio generally adheres to the following practices:
o It invests only in obligations of the U.S. Government and its agencies and
instrumentalities, repurchase agreements secured by such instruments and in
U.S. dollar-denominated debt obligations of "supranational organizations."
"Supranational organizations" are non-governmental entities designated or
supported by a government or governmental entity to promote economic
development, such as the European Community, the International Monetary
Fund, the United Nations and the World Bank.
o It buys instruments maturing in 397 days or less. It can also buy certain
variable and floating rate securities.
o It maintains a dollar-weighted average portfolio maturity of 90 days or
less.
o It may purchase or sell securities on a forward commitment basis.
o It may engage in reverse repurchase agreements and other borrowings as
permitted by applicable law.
Among the principal risks of investing in the Portfolio are Interest Rate Risk
and Credit Risk. Please see "Principal Risks" for a discussion of these and
other risks.
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WESTERN ASSET MONEY MARKET PORTFOLIO
Adviser: Western Asset
Objective: High current income consistent with liquidity and conservation of
principal
The Portfolio is a money market fund that seeks to maintain a net asset value of
$1.00 per share. To achieve its objective, the Portfolio generally adheres to
the following practices:
o It generally invests in money market instruments, such as:
(i) U.S. government obligations
(ii) municipal obligations
(iii) instruments such as certificates of deposit, demand and time
deposits, savings shares and bankers' acceptances issued by domestic
and foreign banks and savings and loan institutions that have over $1
billion in total assets or where the principal amount is insured by
the Federal Deposit Insurance Corporation
(iv) repurchase agreements
(v) reverse repurchase agreements and other borrowings
(vi) commercial paper and other short-term investments
o It invests only in "high quality" money market instruments. "High quality"
money market instruments are those that: (i) have received one of the two
highest ratings by two or more Nationally Recognized Statistical Rating
Organizations ("NRSRO"); (ii) receive one of the two highest ratings by one
NRSRO if only one has rated the security; or (iii) if unrated, are
determined by Western Asset to be of comparable quality.
o It may not invest more than 5% of its total assets in the "first tier"
securities of any one issuer (except for U.S. government obligations).
"First tier" securities are those that: (i) have been rated in the highest
rating category by two NRSROs; (ii) receive the highest rating by one NRSRO
if only one has rated the security; or (iii) if unrated, are determined by
Western Asset to be of comparable quality.
o It may not invest more than 1% of its total assets or $1 million (whichever
is greater) in the "second tier" securities of any one issuer. "Second
tier" securities are all "high quality" securities that are not "first
tier" securities.
o It may not invest more than 5% of its total assets in "second tier"
securities.
o It may invest only in U.S. dollar-denominated securities. These include
foreign investments denominated in U.S. dollars.
o It buys money market securities maturing in 397 days or less. It can also
buy certain variable and floating rate securities.
o It may purchase or sell securities on a forward commitment basis.
o It maintains a dollar-weighted average portfolio maturity of 90 days or
less.
Among the principal risks of investing in the Portfolio are Interest Rate Risk
and Credit Risk. Please see "Principal Risks" for a discussion of these and
other risks.
WESTERN ASSET LIMITED DURATION PORTFOLIO, WESTERN ASSET INTERMEDIATE PORTFOLIO,
WESTERN ASSET INTERMEDIATE PLUS PORTFOLIO, WESTERN ASSET CORE PORTFOLIO, WESTERN
ASSET CORE PLUS PORTFOLIO
Advisers: Western Asset and WAGM (non-U.S. portions of Intermediate Plus and
Core Plus Portfolios)
Objective: Maximize total return, consistent with prudent investment
management and liquidity needs, by investing to obtain the
average duration specified for each Portfolio
Each of these Portfolios invests in a portfolio of fixed income securities of
various maturities to obtain the dollar-weighted average duration specified for
that Portfolio.
To achieve their objectives, the Portfolios invest primarily in:
o U.S. Government obligations
o mortgage- and other asset-backed securities
o U.S. dollar-denominated obligations of foreign governments, international
agencies or supranational organizations
o U.S. dollar-denominated fixed income securities of non-governmental
domestic or foreign issuers
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In addition to the foregoing principal investment strategies, the Portfolios are
also permitted to:
o purchase other securities and instruments, including:
(i) preferred stocks
(ii) structured notes
(iii) municipal obligations
(iv) convertible securities
(v) pay-in-kind securities and zero coupon bonds
(vi) certificates of deposit, time deposits and bankers' acceptances
issued by domestic and foreign banks
(vii) commercial paper and other short-term investments
o invest up to 25% of their total assets in the securities of foreign issuers
o buy or sell futures contracts on fixed income instruments, options on such
futures contracts and options on securities for both hedging and
non-hedging purposes
o buy or sell securities on a forward commitment basis
o lend its portfolio securities
o engage in foreign currency exchange transactions
o engage in repurchase agreements and reverse repurchase agreements
o borrow money for temporary or emergency purposes
Each of the Portfolios may buy and sell investments relatively often, which
involves higher brokerage commissions and other expenses, and may increase taxes
payable by shareholders.
Each Portfolio in this group differs from the others in terms of its investment
policies regarding its target dollar weighted average duration, and the two
"Plus" Portfolios, the Intermediate Plus and Core Plus, differ from the other
Portfolios in terms of their policies with respect to U.S. dollar-denominated
securities and the credit quality of their investments. These differences are
summarized in the following table. "Duration" refers to the range within which
the dollar weighted average duration of a Portfolio is expected to fluctuate.
With respect to the Core and Core Plus Portfolios, the average duration is
expected to range within 20% of the duration of the domestic bond market as a
whole (normally four to six years, although this may vary) as measured by
Western Asset. "Foreign Currency Exposure" refers to whether a Portfolio
presently intends to limit its investments to U.S. dollar-denominated
securities. "Credit Quality" refers to the percentage of a Portfolio's net
assets that may be invested in debt securities that are rated, at the time of
purchase, below investment grade, but at least B or higher by an NRSRO or, if
unrated, determined by the Adviser to be of comparable quality.
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PORTFOLIO DURATION FOREIGN CURRENCY EXPOSURE CREDIT QUALITY
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Limited Duration 1-3 Years U.S. Dollar-Denominated Only Currently Anticipates No Securities
Below Investment Grade
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Intermediate 2-4 Years U.S. Dollar-Denominated Only Currently Anticipates No Securities
Below Investment Grade
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Intermediate Plus 2-4 Years The Portfolio may invest up to 20% Up to 15%
of its total assets in non-U.S. Below Investment Grade
dollar denominated securities.
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Core Generally U.S. Dollar-Denominated Only Currently Anticipates No Securities
4-6 Years Below Investment Grade
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Core Plus Generally The Portfolio may invest up to 20% Up to 15%
4-6 Years of its total assets in non-U.S. Below Investment Grade
dollar- denominated securities.
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Among the principal risks of investing in these Portfolios are Interest Rate
Risk, Credit Risk, Call Risk, Special Risks of Mortgage-Backed and Asset-Backed
Securities, Foreign Securities Risk, Borrowing Risk, Derivatives Risk and
Hedging Risk. In addition, Special Risks of High Yield Securities, Liquidity
Risk and Currency Risk are among the principal risks of investing in the
Intermediate Plus and Core Plus Portfolios. Please see "Principal Risks" for a
discussion of these and other risks.
WESTERN ASSET HIGH YIELD PORTFOLIO
Adviser: Western Asset
Objective: Maximize total return, consistent with prudent investment
management
Under normal market conditions, the Portfolio will invest at least 75% of its
total assets in U.S. dollar-denominated debt or fixed income securities that are
rated below investment grade at the time of purchase by one or more NRSROs or
are of a comparable quality as determined by Western Asset. These securities are
commonly known as "junk bonds" or "high yield bonds." Western Asset expects
that, under normal market conditions, all or substantially all of the
Portfolio's assets will be invested in such securities.
To achieve its objective, the Portfolio may also make other investments,
including:
o mortgage- and other asset-backed securities
o municipal obligations
o variable and floating rate debt securities
o commercial paper and other short-term investments
o corporate obligations ("Corporate obligations") include preferred stock,
convertible securities, zero coupon securities and pay-in-kind securities.)
o common stocks and warrants
o certificates of deposit, fixed time deposits and bankers' acceptances
issued by domestic banks
The Portfolio is also permitted to:
o invest up to 25% of its total assets in foreign currency-denominated
foreign securities
o purchase or sell for hedging or non-hedging purposes: (i) interest rate
futures contracts, (ii) options on fixed income instruments and bond
indices, or (iii) options on interest rate futures contracts
o engage in foreign currency exchange transactions
o lend its securities
o borrow money for temporary or emergency purposes
o buy or sell securities on a forward commitment basis
o engage in repurchase agreements and reverse repurchase agreements
The Portfolio may buy and sell investments relatively often, which involves
higher brokerage commissions and other expenses, and may increase taxes payable
by shareholders.
Among the principal risks of investing in the Portfolio are Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Special Risks of
Mortgage-Backed and Asset-Backed Securities, Market Risk, Foreign Securities
Risk, Liquidity Risk, Borrowing Risk, Emerging Markets Risk, Currency Risk,
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of these and other risks.
WESTERN ASSET NON-U.S. FIXED INCOME PORTFOLIO
Adviser: WAGM
Objective: Maximize total return, consistent with prudent investment
management
Under normal market conditions, the Portfolio invests at least 75% of its total
assets in debt and fixed income securities denominated in major foreign
currencies. WAGM anticipates that, under normal market conditions, all or
substantially all of the Portfolio's assets will be invested in securities of
foreign issuers and that these foreign issuers will represent at least three
foreign countries. Under current market conditions, the Portfolio expects that
substantially all of its currency risk will be hedged to U.S. dollars.
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To achieve its objective, the Portfolio may invest in a variety of securities,
including:
o U.S. dollar-denominated or foreign currency-denominated obligations of
foreign governments, international agencies or supranational entities
o foreign currency exchange-related securities, including foreign currency
warrants
o U.S. Government obligations
o mortgage- and other asset-backed securities
o variable and floating rate debt securities
o commercial paper and other short-term investments
o corporate obligations
o certificates of deposit, fixed time deposits and bankers' acceptances
o loan participations and assignments
o indexed securities and structured notes
o repurchase agreements
The Portfolio may also:
o engage in reverse repurchase agreements
o borrow money for temporary or emergency purposes
o buy or sell for hedging and non-hedging purposes: (i) interest rate futures
contracts and options on fixed income instruments and bond indices and (ii)
options on interest rate futures contracts
o buy or sell foreign currencies, foreign currency options, or foreign
currency futures contracts and related options
o enter into foreign currency forward contracts for hedging and non-hedging
purposes
The Portfolio does not currently intend to invest in securities that are rated
at the time of purchase below investment grade, although it may do so if market
conditions are favorable. The Portfolio is "non-diversified" within the meaning
of the Investment Company Act. See "Principal Risks--Non-Diversification." WAGM
anticipates that from time to time over 25% of the Portfolio's assets may be
invested in securities of issuers located in a single country. Because the
Portfolio may concentrate a significant portion of its investments in a single
country or currency, it will be more susceptible to factors adversely affecting
such currency or issuers within that country than would a more diversified
portfolio of securities. The Portfolio may buy and sell investments relatively
often, which involves higher brokerage commissions and other expenses, and may
increase taxes payable by shareholders.
Among the principal risks of investing in the Portfolio are Interest Rate Risk,
Credit Risk,CallRisk, Special Risks of High Yield Securities, Special Risks of
Mortgage-Backed and Asset-Backed Securities, Market Risk, Foreign Securities
Risk, Emerging Markets Risk, Currency Risk, Borrowing Risk, Derivatives Risk and
Hedging Risk. Please see "Principal Risks" for a discussion of these and other
risks.
WESTERN ASSET GLOBAL STRATEGIC INCOME PORTFOLIO
Advisers: WAGM (non-U.S. portion) and Western Asset (U.S. portion)
Objective: Income and capital appreciation
To achieve its investment objective, the Portfolio invests primarily in various
types of U.S. dollar-denominated and foreign currency-denominated fixed income
securities, including:
o U.S. and foreign corporate fixed income securities
o Debt obligations of corporate and governmental issuers in emerging market
countries (These include "Brady Bonds"; bonds issued as a result of a debt
restructuring plan; Eurobonds; domestic and international bonds issued
under the laws of a developing country; and emerging market loans.)
o sovereign debt obligations of developed nations
o debt obligations of "supranational organizations"
o mortgage- and other asset-backed securities
The Portfolio may invest in a variety of other securities, including:
o foreign currency exchange-related securities, including foreign currency
warrants
o variable and floating rate debt securities
o commercial paper and other short-term investments
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o municipal obligations
o certificates of deposit, fixed time deposits and bankers' acceptances
o loan participations and assignments
o indexed securities and structured notes
o repurchase agreements
The Portfolio may invest up to 60% of its net assets in securities that are
rated at the time of purchase below investment grade or are of comparable
quality at the time of purchase as determined by WAGM or Western Asset. These
securities are commonly known as "junk bonds" or "high yield bonds." The
Portfolio may buy and sell investments relatively often, which involves higher
brokerage commissions and other expenses, and may increase taxes payable by
shareholders.
The Portfolio may also:
o engage in reverse repurchase agreements
o borrow money for temporary or emergency purposes
o loan its portfolio securities
o buy or sell for hedging and non-hedging purposes: (i) bond or interest rate
futures contracts and options on fixed income instruments and bond indexes
and (ii) options on bond or interest rate futures contracts
o buy or sell foreign currencies, foreign currency options, or foreign
currency futures contracts and related options
o enter into foreign currency forward contracts for hedging and non-hedging
purposes
Under normal market conditions, the Portfolio will invest at least 80% of its
total assets in securities of issuers representing at least three countries (one
of which may be the U.S.) and at least 65% of its total assets in income
producing securities. Because the Portfolio may concentrate a significant
portion of its investments in a single country or currency, it will be more
susceptible to factors adversely affecting issuers within that country or
currency than would a more diversified portfolio of securities.
The Portfolio is "non-diversified" within the meaning of the Investment Company
Act. See "Principal Risks--Non-Diversification."
Among the principal risks of investing in the Portfolio are Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Special Risks of
Mortgage-Backed and Asset-Backed Securities, Foreign Securities Risk, Emerging
Markets Risk, Currency Risk, Borrowing Risk, Derivatives Risk and Hedging Risk.
Please see "Principal Risks" for a discussion of these and other risks.
WESTERN ASSET ENHANCED EQUITY PORTFOLIO
Adviser: Western Asset
Objective: Long-term total return
The Portfolio's assets will be comprised of two components: an equity component
and a fixed income component.
o The equity component will generally maintain full exposure to the U.S.
equity market as represented by the S&P 500 Index (the "Index").
o The fixed income component will try to generate interest and gains in
excess of the Portfolio's expenses, including transaction costs related to
its investments.
The Portfolio expects that its performance will approximate that of the Index,
with the extent to which the Portfolio outperforms or underperforms the Index
depending largely on whether the fixed income component has earned sufficient
amounts to offset the Portfolio's expenses. Up to 10% of the Portfolio's net
assets may be invested in securities rated below investment grade at the time of
purchase or unrated securities of comparable quality at the time of purchase
(commonly known as "junk bonds" or "high yield bonds") and up to 20% of its net
assets may be invested in foreign securities. The Portfolio may buy and sell
investments relatively often, which involves higher brokerage commissions and
other expenses, and may increase taxes payable by shareholders. The following
information summarizes the investment practices of the Portfolio's two
components.
EQUITY COMPONENT
The Portfolio's equity component invests primarily in: (i) common stocks that
are represented in the Index ("S&P stocks") and (ii) stock index futures,
options on stock indexes, options on stock index futures and other derivative
instruments that are based on the Index ("S&P derivatives").
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The Equity Component of the Portfolio adheres to the following practices:
o it may invest in any combination of S&P stocks and S&P derivatives.
o it currently plans to invest predominantly, and likely exclusively,
in S&P derivatives.
o it will not be limited to purchasing S&P stocks in the same proportion
as such stocks are weighted in the Index.
o it will seek to remain invested in S&P stocks and S&P derivatives even
when the Index is declining.
The Index is composed of 500 selected common stocks, most of which are listed on
the New York Stock Exchange. Standard and Poor's ("S&P") chooses the stocks to
be included in the Index solely on a statistical basis. The weightings of stocks
in the Index are based on each stock's relative total market value, that is, its
market price per share times the number of shares outstanding. The Portfolio is
neither sponsored by nor affiliated with S&P.
FIXED INCOME COMPONENT
The fixed income component will invest primarily in the following types of fixed
income securities:
o U.S. Government obligations
o securities of non-governmental domestic or foreign issuers n municipal
securities
o mortgage- and other asset-backed securities
o preferred stocks
o obligations of foreign governments, international agencies or supranational
entities
THE FIXED INCOME COMPONENT MAY ALSO:
o invest in other securities or instruments, including:
(i) certificates of deposit, time deposits and bankers' acceptances
issued by domestic and foreign banks
(ii) commercial paper and other short-term investments
(iii) engage in repurchase agreements, reverse repurchase agreements and
other borrowings
(iv) purchase or sell futures contracts and options
(v) engage in foreign currency exchange transactions
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Special Risks of Mortgage-Backed and Asset-Backed Securities,
Foreign Securities Risk, Emerging Markets Risk, Currency Risk, Borrowing Risk,
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of these and other risks.
LM VALUE INSTITUTIONAL PORTFOLIO
Adviser: LMFA
Objective: Long-term growth of capital
The Portfolio invests primarily in equity securities (including common and
preferred stocks), and securities convertible into equity securities, that, in
the Adviser's opinion, offer the potential for capital growth. The Adviser
follows a value discipline in selecting securities, and therefore seeks to
purchase securities at large discounts to the Adviser's assessment of their
intrinsic value. Intrinsic value, according to the Adviser, is the value of the
company measured, to different extents depending on the type of company, on
factors such as, but not limited to, the discounted value of its projected
future free cash flows, the company's ability to earn returns on capital in
excess of its cost of capital, private market values of similar companies, the
value of its assets, and the costs to replicate the business. Qualitative
factors, such as an assessment of the company's products, competitive
positioning, strategy, industry economics and dynamics, regulatory frameworks
and more, are also important. Securities may be undervalued due to uncertainty
arising from the availability of accurate information, economic growth and
change, changes in competitive conditions, technological change, changes in
government policy or geo-political dynamics, and more. The Adviser takes a
long-term approach to investing, generally characterized by long holding periods
and low portfolio turnover. The Portfolio generally invests in companies with
market capitalizations greater than $5 billion, but may invest in companies of
any size.
The Adviser typically sells a security when, in the Adviser's assessment, the
security no longer appears to offer a long-term above average risk-adjusted rate
of return, when a more compelling investment opportunity is found, or when the
investment basis no longer applies.
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The Portfolio may also invest in debt securities of companies having one or more
of the above characteristics. The Portfolio may invest up to 25% of its net
assets in long-term debt securities. Up to 10% of its total assets may be
invested in convertible and/or debt securities rated below investment grade,
i.e., not rated at least BBB by Standard & Poor's or Baa by Moody's Investors
Service, Inc. or, if unrated by those entities, deemed by the Adviser to be of
comparable quality, and commonly referred to as junk bonds.
For temporary purposes, or when cash is temporarily available, the Portfolio may
invest without limit in investment grade, short-term debt instruments, including
government, corporate and money market securities. The Portfolio may not achieve
its investment objective when so invested.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
LM SPECIAL INVESTMENT INSTITUTIONAL PORTFOLIO
Adviser: LMFA
Objective: Capital appreciation
The Portfolio invests primarily in equity securities, and securities convertible
into equity securities, of companies whose market capitalizations are typically
classified as small to mid-sized. The Adviser defines small to mid-sized
companies as those below the top 500 U.S. companies in terms of market
capitalization. It also invests in "special situations" without regard to market
capitalization. Special situations are companies undergoing unusual or possibly
one-time developments that, in the opinion of the Adviser, make them attractive
for investment. Such developments may include actual or anticipated: sale or
termination of an unprofitable part of the company's business; change in the
company's management or in management's philosophy; a basic change in the
industry in which the company operates; introduction of new products or
technologies; or the prospect or effect of acquisition or merger activities.
The Adviser follows a value discipline in selecting securities, and therefore
seeks to purchase securities at large discounts to the Adviser's assessment of
their intrinsic value. Intrinsic value, according to the Adviser, is the value
of the company measured, to different extents depending on the type of company,
on factors such as, but not limited to, the discounted value of its projected
future free cash flows, the company's ability to earn returns on capital in
excess of its cost of capital, private market values of similar companies, the
value of its assets, and the costs to replicate the business. Qualitative
factors, such as an assessment of the company's products, competitive
positioning, strategy, industry economics and dynamics, regulatory frameworks
and more, are also important. Securities may be undervalued due to uncertainty
arising from the availability of accurate information, economic growth and
change, changes in competitive conditions, technological change, changes in
government policy or geo-political dynamics, and more.
The Portfolio also invests in debt securities of companies having one or more of
the above characteristics. The Portfolio may invest up to 35% of its net assets
in debt securities rated below investment grade, i.e., rated below BBB/Baa (or,
if unrated, determined by the Adviser to be of comparable quality) and commonly
referred to as junk bonds. The Portfolio may invest up to 20% of its total
assets in securities of companies involved in actual or anticipated
reorganizations or restructurings.
The Adviser typically sells a security when, in the Adviser's assessment, the
security no longer appears to offer a long-term above average risk-adjusted rate
of return, when a more compelling investment opportunity is found, or when the
investment basis no longer applies.
For temporary defensive purposes, or when cash is temporarily available, the
Portfolio may invest without limit in investment grade, short-term debt
instruments, including government, corporate and money market securities. The
Portfolio may not achieve its investment objective when so invested.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk, and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
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LM TOTAL RETURN INSTITUTIONAL PORTFOLIO
Adviser: LMFA
Objective: Capital appreciation and current income in order to achieve an
attractive total investment return consistent with reasonable
risk
The Portfolio invests primarily in securities that, in the Adviser's opinion,
offer the potential for long-term capital growth and attractive current income.
The Portfolio invests primarily in common stocks, debt securities, and
securities convertible into common stocks, but is not limited to these types of
securities. The Portfolio may invest in securities that do not pay current
income but do, in the Adviser's opinion, offer prospects for capital
appreciation and/or future income. The Adviser follows a value discipline in
selecting securities, and therefore seeks to purchase securities at large
discounts to the Adviser's assessment of their intrinsic value. Intrinsic value,
according to the Adviser, is the value of the company measured, to different
extents depending on the type of company, on factors such as, but not limited
to, the discounted value of its projected future free cash flows, the company's
ability to earn returns on capital in excess of its costs of capital, private
market values of similar companies, the value of its assets, and the costs to
replicate the business. Qualitative factors, such as an assessment of the
company's products, competitive positioning, strategy, industry economics and
dynamics, regulatory frameworks and more, are also important. Securities may be
undervalued due to uncertainty arising from the availability of accurate
information, economic growth and change, changes in competitive conditions,
technological change, changes in government policy or geo-political dynamics,
and more. The Portfolio may invest in companies of any size.
The Adviser typically sells a security when, in the Adviser's assessment, the
security no longer appears to offer long-term attractive total returns at
reasonable risk, when a more compelling investment opportunity is found, or when
the investment basis no longer applies. The Portfolio may invest in money market
securities for temporary defensive purposes or when cash is temporarily
available. The Portfolio may not achieve its investment objective when so
invested. Consistent with the investment objective, the Portfolio may also
invest in debt securities when the Adviser believes the return on such
securities may equal or exceed the return on equity securities. The Portfolio
may invest in debt securities of any maturity of both foreign and domestic
issuers without regard to rating, and may invest its assets in debt securities
without regard to a percentage limit. The Adviser currently anticipates that
under normal market conditions the Portfolio will invest no more than 50% of its
total assets in intermediate-term and long-term debt securities and no more than
5% of its total assets in debt securities not rated investment grade (commonly
referred to as junk bonds).
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk,CallRisk, Special Risks of High Yield
Securities, Liquidity Risk, Borrowing Risk and Hedging Risk. Please see
"Principal Risks" for a discussion of these and other risks.
BRANDYWINE SMALL CAP VALUE PORTFOLIO
Adviser: Brandywine
Objective: Long-term capital appreciation
Under normal market conditions, the Portfolio will invest at least 65% of its
total assets in equity securities of "small cap" companies. "Small cap"
companies are generally defined as companies at the time of initial investment
with an equity market capitalization not in excess of the 40th percentile of the
capitalization of issuers traded on the New York Stock Exchange (currently
approximately $1 billion). A company that was a "small cap" company at the time
of the Portfolio's initial investment will continue to be treated as such for
purposes of the 65% test, even if the equity capitalization exceeds the 40th
percentile at a time subsequent to investment. Equity securities include common
stock, preferred stock, securities convertible into common stock, rights and
warrants to acquire such securities and substantially similar forms of equity
with comparable risk characteristics.
Although the Portfolio expects to remain substantially fully invested in equity
securities, the Portfolio may invest in cash and money market instruments,
including repurchase agreements. For temporary defensive purposes, the Portfolio
may also invest in investment grade debt and fixed income investments. The
Portfolio may not achieve its investment objective when so invested. The
Portfolio may also engage in reverse repurchase agreement transactions and other
borrowings, purchase restricted and illiquid securities, loan its portfolio
securities, and invest in securities of other investment companies.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Liquidity Risk, Borrowing Risk, and Hedging Risk. Please see
"Principal Risks" for a discussion of these and other risks.
11
<PAGE>
BATTERYMARCH INTERNATIONAL EQUITY PORTFOLIO
Adviser: Batterymarch
Objective: Long-term total return
Under normal market conditions, the Portfolio will invest substantially all of
its assets, but in any event at least 65% of its total assets, in non-U.S.
equity securities.
The primary focus of the Adviser is stock selection, with a secondary focus on
country allocation. The Adviser uses a bottom-up, quantitative stock selection
process for the developed markets portion of the Portfolio's portfolio. The
cornerstone of this process is a proprietary stock selection model that ranks
the 2,800 stocks in the Portfolio's investable universe by relative
attractiveness on a daily basis. The quantitative factors within this model are
intended to measure growth, value, fundamental expectations and technical
indicators (i.e., supply and demand).
Country allocation for the developed markets portion of the Portfolio is based
on rankings generated by the Adviser's proprietary country model. The Adviser
examines securities from over 20 international stock markets, with emphasis on
several of the largest: Japan, United Kingdom, France, Canada and Germany.
The Portfolio may invest up to 35% of its total assets in emerging market equity
securities. The Adviser's investment strategy for the emerging markets portion
of the Portfolio represents a distinctive combination of tested quantitative
methodology and traditional fundamental analysis. The emerging markets
allocation focuses on higher-quality, dominant companies which the Adviser
believes to have strong growth prospects and reasonable valuations. Country
allocation for the emerging markets portion of the Portfolio also combines
quantitative and fundamental approaches.
The Portfolio will normally be invested across a broad range of industries and
across a number of countries, consistent with the objective of maximum total
return. However, more than 25% of the Portfolio's total assets may be invested
in securities of issuers located in a single country, which is currently
expected to be the case with respect to both Japan and the United Kingdom.
Because the Portfolio may concentrate a significant portion of its investments
in a single country or currency, it will be more susceptible to factors
adversely affecting such currency or issuers within that country than would a
more diversified portfolio of securities.
The Portfolio may invest without limit in cash and money market instruments,
including repurchase agreements, in circumstances when cash is temporarily
available, or for temporary defensive purposes when the Adviser believes such
action is warranted by abnormal market or economic situations. Up to 5% of the
Portfolio's total assets may be rated below investment grade or, if unrated,
determined by the Adviser to be below investment grade. The Adviser may also
seek to enhance portfolio returns through active currency hedging strategies,
although there can be no assurances that such strategies will be pursued or, if
pursued, will be successful.
Among the principal risks of investing in the Portfolio are Market Risk, Foreign
Securities Risk, Emerging Markets Risk, Currency Risk, Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Borrowing Risk,
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of these and other risks.
BATTERYMARCH EMERGING MARKETS PORTFOLIO
Adviser: Batterymarch
Objective: Long-term capital appreciation
Under normal market conditions, the Portfolio will invest substantially all of
its assets, but in any event at least 65% of its total assets, in equity
securities and convertible securities of emerging market issuers. Emerging
market countries are those countries having less fully developed economic and
political systems and include any country: (i) having an "emerging stock market"
or considered a "frontier market" as defined by the International Finance
Corporation; (ii) with low- to middle-income economies according to the
International Bank for Reconstruction and Development ("World Bank"); (iii)
listed in World Bank publications as developing; or (iv) included in the Morgan
Stanley Capital International (MSCI) Emerging Markets published index. Emerging
market equity securities include common stock, preferred stock, securities
convertible into common stock, rights and warrants to acquire such securities
and substantially similar forms of equity with comparable risk characteristics
that are: (1) publicly traded on emerging market stock exchanges, or whose
principal trading market is over-the-counter (i.e., off-exchange) in an emerging
market country; (2) securities denominated in any currency if issued by
companies to finance operations in an emerging market country; (3) securities of
companies that derive a substantial portion (i.e., in excess of 50%) of their
total
12
<PAGE>
revenues from goods or services produced in, or sales made in, emerging market
countries; (4) securities of companies organized under the laws of an emerging
market country or region, which are publicly traded in securities markets
elsewhere; or (5) American depositary receipts ("ADRs") (or similar instruments)
with respect to the foregoing.
The Portfolio intends to invest in Asia, Latin America, the Indian Subcontinent,
Southern and Eastern Europe, the Middle East and Africa, although it may not
invest in all these markets at all times and may not invest in any particular
market when it deems investment in that country or region to be inadvisable.
More than 25% of the Portfolio's total assets may be invested in securities of
issuers located in a single country. Because the Portfolio may concentrate a
significant portion of its investments in a single country or currency, it will
be more susceptible to factors adversely affecting such currency or issuers
within that country than would a more diversified portfolio of securities.
The Adviser focuses on higher-quality, dominant emerging markets companies which
the Adviser believes to have strong growth prospects and reasonable valuations,
selected from an investable universe of approximately 1,000 stocks. The
Adviser's emerging markets investment strategy represents a distinctive
combination of quantitative methodology and traditional fundamental analysis.
Traditional "on-the-ground" fundamental research is combined by the Adviser with
tested quantitative valuation disciplines in those markets where reliable data
is available. In determining country allocation, the Adviser also merges
quantitative and fundamental approaches.
The Portfolio may invest without limit in cash and money market instruments,
including repurchase agreements, in circumstances when cash is temporarily
available, or for temporary defensive purposes when the Adviser believes such
action is warranted by abnormal market or economic situations. The Portfolio may
not achieve its investment objective when so invested. Up to 10% of the
Portfolio's total assets may be rated below investment grade or, if unrated,
determined by the Adviser to be below investment grade (i.e., rated below
BBB/Baa and commonly referred to as Junk Bonds).
Among the principal risks of investing in the Portfolio are Market Risk, Foreign
Securities Risk, Emerging Markets Risk, Currency Risk, Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Borrowing Risk,
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of those and other risks.
PRINCIPAL RISKS
In General
At any time, your investment in a mutual fund may be worth more or less than the
price you originally paid for it. You may lose money by investing in any of
these Portfolios because: (i) the value of the investments it owns changes,
sometimes rapidly and unpredictably; (ii) the Portfolio is not successful in
reaching its goal because of its strategy or because it did not implement its
strategy properly; or (iii) unforeseen occurrences in the securities markets
negatively affect the Portfolio.
An investment in the Western Asset Government Money Market and Western Asset
Money Market Portfolios is not a deposit of a bank and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency. Although the Western Asset Government Money Market and Western Asset
Money Market Portfolios seek to preserve the value of your investment at $1.00
per share, it is possible to lose money by investing in these Portfolios.
The following risks apply to the Portfolios. You should read this section
carefully before you invest in order to learn more about the Portfolio in which
you will invest.
Market Risk
Certain of the Portfolios may invest substantially all of their assets in equity
securities. Prices of equity securities generally fluctuate more than those of
other securities. A Portfolio may experience a substantial or complete loss on
an individual stock. Market risk may affect a single issuer, industry or section
of the economy or may affect the market as a whole. The Batterymarch
International Equity Portfolio and the Batterymarch Emerging Markets Portfolio
invest primarily in foreign equity securities. Foreign securities have
additional risks, see "Foreign Securities Risk" below.
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<PAGE>
Securities of "small cap" companies entail special risks. Such companies often
have limited operating histories and may have more restricted product lines or
more limited financial resources than larger, more established companies. For
these and other reasons, they may be more severely affected by economic
downturns or other adverse developments than are larger, more established
companies. Securities of "small cap" companies may be traded "over-the-counter"
and often trade less frequently and in more limited volume, may be subject to
greater volatility and may be more difficult to value than securities of larger,
more established companies. "Small cap" companies are often involved in actual
or anticipated reorganizations or restructurings, which involve special risks,
including difficulty in obtaining information as to the financial condition of
such companies and the fact that market prices of such companies' securities are
subject to sudden and erratic price volatility. The securities of "mid-sized"
companies share many of these same risks.
Foreign Securities Risk
Investments in foreign securities (including those denominated in U.S. dollars)
involve certain risks not typically associated with investments in domestic
issuers. The values of foreign securities are subject to economic and political
developments in the countries and regions where the companies operate, such as
changes in economic or monetary policies, and to changes in exchange rates.
Values may also be affected by restrictions on receiving the investment proceeds
from a foreign country.
In general, less information is publicly available about foreign companies than
about U.S. companies. Foreign companies are generally not subject to the same
accounting, auditing and financial reporting standards as are U.S. companies.
Some securities issued by foreign governments or their subdivisions, agencies
and instrumentalities may not be backed by the full faith and credit of the
foreign government. Even where a security is backed by the full faith and credit
of a foreign government, it may be difficult for a Portfolio to pursue its
rights against a foreign government in that country's courts. Some foreign
governments have defaulted on principal and interest payments.
In addition, a Portfolio's investments in foreign securities may be subject to
the risk of nationalization or expropriation of assets, imposition of currency
exchange controls or restrictions on the repatriation of foreign currency,
complications with the European markets' conversion to the Euro, confiscatory
taxation, political or financial instability and diplomatic developments which
could effect the value of a Portfolio's investments in certain foreign
countries. Dividends or interest on, or proceeds from the sale of, foreign
securities may be subject to foreign withholding taxes, and special U.S. tax
considerations may apply.
Emerging Markets Risk
The risks of foreign investment are greater for investments in emerging markets.
Among others, these types of investments can include not only equity securities,
but also "Brady Bonds," bonds issued as a result of a debt restructuring plan,
Eurobonds, domestic and international bonds issued under the laws of a
developing country, and emerging market loans. Emerging market countries
typically have economic and political systems that are less fully developed, and
can be expected to be less stable than those of more advanced countries. Low
trading volumes may result in a lack of liquidity and in price volatility.
Emerging market countries may have policies that restrict investment by
foreigners, or that prevent foreign investors from withdrawing their money at
will.
Because some of the Portfolios may invest a significant amount of their total
assets in emerging market securities, investors should be able to tolerate
sudden and sometimes substantial fluctuations in the value of their investments.
An investment in any Portfolio that invests in emerging market securities, which
includes the Batterymarch Emerging Markets Portfolio, Batterymarch International
Equity Portfolio, Western Asset High Yield Portfolio, Western Asset Non-U.S.
Fixed Income Portfolio and Western Asset Global Strategic Income Portfolio,
should be considered speculative.
CURRENCY RISK
Because certain Portfolios may invest significantly in securities denominated in
foreign currencies, their value can be affected by changes in the rates of
exchange between those currencies and the U.S. dollar. Currency exchange rates
can be volatile and affected by, among other factors, the general economics of a
country, the actions of the U.S. and foreign governments or central banks, the
imposition of currency controls, and speculation. A security may be denominated
in a currency that is different from the currency where the issuer is domiciled.
14
<PAGE>
The Portfolios from time to time hedge a portion of their currency risk, using a
variety of techniques, including currency futures, forwards, or options.
However, these instruments may not always work as intended, and in specific
cases a Portfolio may be worse off than if it had not used a hedging instrument.
For most emerging market currencies, there are not suitable hedging instruments
available. See "Hedging Risk" below.
Interest Rate Risk
Each Portfolio is subject to interest rate risk, which is the possibility that
the market prices of the Portfolios' investments may decline due to an increase
in market interest rates. Generally, the longer the maturity of a fixed-income
security, the greater is the effect on its value when rates increase.
Certain securities pay interest at variable or floating rates. Variable rate
securities reset at specified intervals, while floating rate securities reset
whenever there is a change in a specified index rate. In most cases, these reset
provisions reduce the effect of market interest rates on the value of the
security. However, some securities do not track the underlying index directly,
but reset based on formulas that can produce an effect similar to leveraging;
others may provide for interest payments that vary inversely with market rates.
The market prices of these securities may fluctuate significantly when interest
rates change.
Credit Risk
Each Portfolio is also subject to credit risk, i.e., the risk that an issuer of
securities will be unable to pay principal and interest when due, or that the
value of the security will suffer because investors believe the issuer is less
able to pay. This is broadly gauged by the credit ratings of the securities in
which each Portfolio invests. However, ratings are only the opinions of the
agencies issuing them and are not absolute guarantees as to quality.
Moody's Investors Service considers debt securities rated Baa to have
speculative characteristics. Debt securities rated below Baa/BBB are deemed by
the rating agencies to be speculative and may involve major risk of exposure to
adverse conditions. These ratings may indicate that the securities are highly
speculative and may be in default or in danger of default as to principal and
interest.
Not all government securities are backed by the full faith and credit of the
United States. Some are backed only by the credit of the issuing agency or
instrumentality. Accordingly, there is at least a chance of default on these
securities.
Call Risk
Many fixed income securities, especially those issued at high interest rates,
provide that the issuer may repay them early. Issuers often exercise this right
when interest rates are low. Accordingly, holders of callable securities may not
benefit fully from the increase in value that other fixed income securities
experience when rates decline. Furthermore, the Portfolios reinvest the proceeds
of the payoff at current yields, which are lower than those paid by the security
that was paid off.
Special Risks of High Yield Securities
Securities rated below Baa/BBB, commonly known as junk bonds or high yield
securities, have speculative characteristics. Accordingly, there is a greater
possibility that the issuers of these securities may be unable to make timely
payments of interest and principal and thus default. If this happens, or is
perceived as likely to happen, the values of these investments will usually be
more volatile. These securities may be less liquid than higher-rated securities,
which means a Portfolio may have difficulty selling them at times, and may have
to apply a greater degree of judgment in establishing a price.
Although the Advisers consider credit ratings in making investment decisions,
they perform their own investment analysis and do not rely on ratings assigned
by the rating agencies. When a Portfolio buys lower rated debt, the achievement
of its goals depends more on the Advisers' ability than would be the case if a
Portfolio were buying investment grade debt.
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<PAGE>
Borrowing Risk
When a Portfolio is borrowing money or otherwise leveraging its portfolio, the
value of an investment in that Portfolio will be more volatile and all other
risks will tend to be compounded. This is because leverage tends to exaggerate
the effect of any increase or decrease in the value of a Portfolio's holdings.
Portfolios may take on borrowing risk by using reverse repurchase agreements,
dollar rolls and other borrowings, by investing collateral from loans of
portfolio securities, through the use of when-issued, delayed-delivery or
forward commitment transactions or by using other derivatives. The use of
leverage may also cause a Portfolio to liquidate positions when it may not be
advantageous to do so to satisfy its obligations or meet segregation
requirements.
Liquidity Risk
Liquidity risk exists when particular investments are difficult to sell. A
Portfolio may not be able to sell these illiquid investments at the best prices.
Investments in derivatives, foreign investments, restricted securities,
securities having small market capitalization, and securities having substantial
market and/or credit risk tend to involve greater liquidity risk.
Special Risks of Mortgage-Backed and Asset-Backed Securities
Mortgage-backed securities represent an interest in a pool of mortgages. When
market interest rates decline, many mortgages are refinanced, and
mortgage-backed securities are paid off earlier than expected. Prepayments may
also occur on a scheduled basis or due to foreclosure. The effect on a
Portfolio's return is similar to that discussed above for call risk.
When market interest rates increase, the market values of mortgage-backed
securities decline. At the same time, however, mortgage refinancings and
prepayments slow, which lengthens the effective maturities of these securities.
As a result, the negative effect of the rate increase on the market value of
mortgage-backed securities is usually more pronounced than it is for other types
of fixed income securities, potentially increasing the volatility of a
Portfolio.
Asset-backed securities are structured like mortgage-backed securities, but
instead of mortgage loans or interests in mortgage loans, the underlying assets
may include such items as motor vehicle installment sales or installment loan
contracts, leases of various types of real and personal property, and
receivables from credit card agreements. The ability of an issuer of
asset-backed securities to enforce its security interest in the underlying
assets may be limited. Asset-backed securities are subject to many of the same
risks as mortgage-backed securities.
Prepayments may cause losses on securities purchased at a premium. At times,
some of the mortgage-backed and asset-backed securities in which a Portfolio may
invest will have higher than market interest rates and therefore will be
purchased at a premium above their par value. Unscheduled prepayments, which are
made at par, will cause a Portfolio to experience a loss equal to any
unamortized premium.
Year 2000
Like other mutual funds (and most organizations around the world), the
Portfolios could be adversely affected by computer problems related to the year
2000. These could interfere with operations of the Portfolios, their Manager,
distributor or Adviser, or could impact companies in which the Portfolios
invest.
While no one knows if these problems will have any impact on the Portfolios or
on financial markets in general, the manager and its affiliates are taking steps
to protect fund investors. These include efforts to determine that the problem
will not directly affect the systems used by major service providers.
Whether these steps will be effective can only be known for certain in the year
2000.
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<PAGE>
Non-Diversification
The Western Asset Non-U.S. Fixed Income Portfolio and the Western Asset Global
Strategic Income Portfolio are non-diversified, meaning each may invest a
greater percentage of its total assets in securities of any one issuer, or may
invest in a smaller number of different issuers, than it could if it were a
"diversified" company under the Investment Company Act. When the Portfolios'
assets are invested in the securities of a limited number of issuers, or in a
limited number of countries or currencies, the value of its shares will be more
susceptible to any single economic, political or regulatory event than shares of
a more diversified fund.
Derivatives Risk
A Portfolio may engage in a variety of transactions using "derivatives," such as
futures, options, warrants and swaps. Derivatives are financial instruments
whose value depends upon, or is derived from, the value of something else, such
as one or more underlying investments, indexes or currencies. Derivatives may be
traded on organized exchanges, or in individually negotiated transactions with
other parties (these are known as "over the counter"). A Portfolio may use
derivatives both for hedging and non-hedging purposes. Although the Advisers
have the flexibility to use these strategies, they may choose not to for a
variety of reasons, even under very volatile market conditions.
Derivatives involve special risks and costs and may result in losses to a
Portfolio. The successful use of derivatives requires sophisticated management,
and the Portfolios will depend on the Advisers' ability to analyze and manage
derivatives transactions. The prices of derivatives may move in unexpected ways,
especially in abnormal market conditions. Some derivatives are "leveraged" and
therefore may magnify or otherwise increase investment losses to a Portfolio. A
Portfolio's use of derivatives may also increase the amount of taxes payable by
shareholders.
Other risks arise from the potential inability to terminate or sell derivatives
positions. A liquid secondary market may not always exist for a Portfolio's
derivatives positions at any time. In fact, many over-the-counter instruments
will not be liquid. Over-the-counter instruments also involve the risk that the
other party will not meet its obligations to a Portfolio.
Hedging Risk
The decision as to whether and to what extent a Portfolio will engage in hedging
transactions to hedge against such risks as credit risk, currency risk and
market risk will depend on a number of factors, including prevailing market
conditions, the composition of the Portfolio and the availability of suitable
transactions. Accordingly, there can be no assurance that a Portfolio will
engage in hedging transactions at any given time or from time to time or that
any such strategies will be successful.
Turnover
The investment strategies employed by the Portfolios often involve high turnover
rates. This results in higher trading costs and could cause a Portfolio to
realize higher levels of taxable gains.
Other Policies
In addition to the investment strategies described above, a Portfolio may also
make other types of investments, and therefore may be subject to other risks.
Some of these risks are described in each Portfolio's Statement of Additional
Information ("SAI"). The terms "debt" and "fixed income securities" are used in
this Prospectus interchangeably, and, where used, are not intended to be
limiting.
At times the Advisers may judge that market conditions make pursuing a
Portfolio's investment strategies inconsistent with the best interests of its
shareholders. The Advisers then may temporarily use alternative strategies that
are mainly designed to limit a Portfolio's losses. Although the Advisers have
the flexibility to use these strategies, they may choose not to for a variety of
reasons, even in very volatile market conditions. These strategies may cause a
Portfolio to miss out on investment opportunities, and may prevent a Portfolio
from achieving its goal. In addition, an Adviser may also keep a portion of a
Portfolio's assets in cash for temporary or defensive purposes, in order to meet
redemption requests, or for investment purposes.
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Except for the investment objective of each of the Western Asset Core, Western
Asset Limited Duration, Western Asset Intermediate and Western Asset Money
Market Portfolios, the Directors may change a Portfolio's investment objective,
investment strategies and other policies without shareholder approval.
PERFORMANCE INFORMATION
The following information provides some indication of a Portfolio's risks. The
charts and tables show year-to-year changes in the performance of the
Institutional Class shares for the Western Asset Core, Western Asset
Intermediate and Western Asset Limited Duration Portfolios. The tables following
the charts compare each Portfolio's performance to that of a broad measure of
market performance. There are no charts and tables for the other Portfolios
because they have less than a full calendar year of performance to report. In
addition, no information is given on the Financial Intermediary Class shares
because this Class has less than a full calendar year of performance to report.
However, the performance for this Class would be lower for each Portfolio since
this Class has higher expenses. Of course, a Portfolio's past performance is not
an indication of future performance.
Core Portfolio
Calendar-Year Total Returns
Best quarter: second quarter 1995, +6.91%
Worst quarter: first quarter 1994, -2.60%
More recent return information: January 1, 1999 - June 30, 1999, -1.99%
[GRAPH HERE WITH FOLLOWING PLOT POINTS]
1991 1992 1993 1994 1995 1996 1997 1998
18.02 7.85 13.86 -4.33 20.97 3.70 10.17 8.34
Core Portfolio
Average Annual Total Returns
for periods ended December 31, 1998
<TABLE>
<CAPTION>
Portfolio Inception
1 Year 5 Years (September 4, 1990)
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Core Portfolio 8.34% 7.45% 9.89%
- -------------------------------------------------------------------------------------
Salomon Broad Market Index* 8.72% 7.29% 9.10%**
</TABLE>
* The Salomon Brothers Broad Market Index is an unmanaged index that measures
the performance of the investment-grade universe of bonds issued in the United
States. The Index includes institutionally traded U.S. Treasury,
government-sponsored, mortgage and corporate securities. The Index does not
incur fees and expenses and cannot be purchased directly by investors.
**The average annual total return since inception shown for the Index is from
August 31, 1990.
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Intermediate Portfolio
Calendar-Year Total Returns
Best quarter: second quarter 1995, +5.17%
Worst quarter: first quarter 1996, -0.61%
More recent return information: January 1, 1999 - June 30, 1999, -0.50%
[GRAPH HERE WITH THE FOLLOWING PLOT POINTS]
1995 1996 1997 1998
15.51 4.69 8.40 7.71
Intermediate Portfolio
Average Annual Total Returns
for periods ended December 31, 1998
Portfolio Inception
1 Year (July 1, 1994)
- --------------------------------------------------------------------------------
Intermediate Portfolio 7.71% 8.09%
- --------------------------------------------------------------------------------
Lehman Intm Gov't/Corp Bond Index* 8.42% 7.98%**
* The Lehman Brothers Intermediate Gov't/Corp Bond Index is an unmanaged index
that measures the performance of intermediate (1-10 year) government and
corporate fixed-rate debt issues. The Index does not incur fees and expenses and
cannot be purchased directly by investors.
**The average annual total return since inception shown for the Index is from
June 30, 1994.
Limited Duration Portfolio
Calendar-Year Total Returns
Best quarter: second quarter 1997, +2.36%
Worst quarter: fourth quarter 1998, +0.21%
More recent return information: January 1, 1999 - June 30, 1999, +1.13%
[GRAPH HERE WITH THE FOLLOWING PLOT POINTS]
1997 1998
7.02 5.74
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Limited Duration Portfolio
Average Annual Total Returns
for periods ended December 31, 1998
Portfolio Inception
1 Year (May 1, 1996)
- --------------------------------------------------------------------------------
Limited Duration Portfolio 5.74% 6.70%
- --------------------------------------------------------------------------------
Merrill Lynch 1-3 Yr Gov't Index* 7.00% 6.83%**
* The Merrill Lynch 1-3 year Government Index is an unmanaged index that
measures the performance of U.S. Treasuries with maturities between 1 and 3
years. The Index does not incur fees and expenses and cannot be purchased
directly by investors.
**The average annual total return since inception shown for the Index is from
April 30, 1996. expense information
FEES AND EXPENSES
The following tables describe the fees and expenses that you may pay if you buy
and hold shares of a Portfolio.
The examples below the tables are intended to help you compare the cost of
investing in a Portfolio with the cost of investing in other mutual funds. The
examples assume that you invest $10,000 in a Portfolio for the time periods
indicated and then redeem all of your shares at the end of those periods. The
examples also assume that your investment has a 5% return each year and that the
Portfolio's operating expenses remain the same. Your actual costs may be higher
or lower.
WESTERN ASSET GOVERNMENT MONEY MARKET PORTFOLIO
<TABLE>
<CAPTION>
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
<S> <C> <C>
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.20% 0.20%
Distribution (12b-1) Fees* None 0.10%
Other Expenses 0.15% 0.15%
-------- --------
Total Annual Fund Operating Expenses 0.35% 0.45%
======== ========
Expense Reimbursement/Waiver (0.05%) (0.05%)
======== ========
Net Expenses** 0.30% 0.40%
======== ========
Examples
1 Year $36 $46
3 Years $113 $144
20
<PAGE>
WESTERN ASSET MONEY MARKET PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.20% 0.20%
Distribution (12b-1) Fees* None 0.10%
Other Expenses 0.15% 0.15%
-------- --------
Total Annual Fund Operating Expenses 0.35% 0.45%
======== ========
Expense Reimbursement/Waiver (0.05%) (0.05%)
======== ========
Net Expenses** 0.30% 0.40%
======== ========
Examples
1 Year $36 $46
3 Years $113 $144
WESTERN ASSET LIMITED DURATION PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.35% 0.35%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.40% 0.40%
-------- --------
Total Annual Fund Operating Expenses 0.75% 1.00%
======== ========
Expense Reimbursement/Waiver (0.35%) (0.35%)
======== ========
Net Expenses** 0.40% 0.65%
======== ========
Examples
1 Year $77 $102
3 Years $240 $318
5 Years $417 $552
10 Years $930 $1,225
WESTERN ASSET INTERMEDIATE PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.40% 0.40%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.08% 0.08%
-------- --------
Total Annual Fund Operating Expenses 0.48% 0.73%
======== ========
Expense Reimbursement/Waiver (0.03%) (0.03%)
======== ========
Net Expenses** 0.45% 0.70%
======== ========
21
<PAGE>
Examples
1 Year $49 $75
3 Years $154 $233
5 Years $269 $406
10 Years $604 $906
WESTERN ASSET INTERMEDIATE PLUS PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.40% 0.40%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.15% 0.15%
-------- --------
Total Annual Fund Operating Expenses 0.55% 0.80%
======== ========
Expense Reimbursement/Waiver (0.10%) (0.10%)
======== ========
Net Expenses** 0.45% 0.70%
======== ========
Examples
1 Year $56 $82
3 Years $176 $255
WESTERN ASSET CORE PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.45% 0.45%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.05% 0.05%
-------- --------
Total Annual Fund Operating Expenses 0.50% 0.75%
======== ========
Examples
1 Year $51 $77
3 Years $160 $240
5 Years $280 $417
10 Years $628 $930
WESTERN ASSET CORE PLUS PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.45% 0.45%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.20% 0.20%
-------- --------
Total Annual Fund Operating Expenses 0.65% 0.90%
======== ========
Expense Reimbursement/Waiver (0.15%) (0.15%)
======== ========
Net Expenses** 0.50% 0.75%
======== ========
22
<PAGE>
Examples
1 Year $66 $92
3 Years $208 $287
5 Years $362 $498
10 Years $810 $1,108
WESTERN ASSET HIGH YIELD PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.55% 0.55%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.15% 0.15%
-------- --------
Total Annual Fund Operating Expenses 0.70% 0.95%
======== ========
Expense Reimbursement/Waiver (0.15%) (0.15%)
======== ========
Net Expenses** 0.55% 0.80%
======== ========
Examples
1 Year $72 $97
3 Years $224 $303
WESTERN ASSET NON-U.S. FIXED INCOME PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.45% 0.45%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.40% 0.40%
-------- --------
Total Annual Fund Operating Expenses 0.85% 1.10%
======== ========
Expense Reimbursement/Waiver (0.30%) (0.30%)
======== ========
Net Expenses** 0.55% 0.80%
======== ========
Examples
1 Year $87 $112
3 Years $271 $350
5 Years $471 $606
10 Years $1,049 $1,340
23
<PAGE>
WESTERN ASSET GLOBAL STRATEGIC INCOME PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.45% 0.45%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.40% 0.40%
-------- --------
Total Annual Fund Operating Expenses 0.85% 1.10%
======== ========
Expense Reimbursement/Waiver (0.05%) (0.05%)
======== ========
Net Expenses** 0.80% 1.05%
======== ========
Examples
1 Year $87 $112
3 Years $271 $350
WESTERN ASSET ENHANCED EQUITY PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.55% 0.55%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.20% 0.20%
-------- --------
Total Annual Fund Operating Expenses 0.75% 1.00%
======== ========
Expense Reimbursement/Waiver (0.10%) (0.10%)
======== ========
Net Expenses** 0.65% 0.90%
======== ========
Examples
1 Year $77 $102
3 Years $240 $318
LM Value Institutional Portfolio
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.60% 0.60%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.48% 0.48%
-------- --------
Total Annual Fund Operating Expenses 1.08% 1.33%
======== ========
Expense Reimbursement/Waiver (0.33%) (0.33%)
======== ========
Net Expenses** 0.75% 1.00%
======== ========
Examples
1 Year $110 $135
3 Years $343 $421
5 Years $595 $729
10 Years $1,317 $1,601
24
<PAGE>
LM SPECIAL INVESTMENT INSTITUTIONAL PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.60% 0.60%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.25% 0.25%
-------- --------
Total AnnualFund Operating Expenses 0.85% 1.10%
======== ========
Expense Reimbursement/Waiver (0.10%) (0.10%)
======== ========
Net Expenses** 0.75% 1.00%
======== ========
Examples
1 Year $87 $112
3 Years $271 $350
LM TOTAL RETURN INSTITUTIONAL PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.60% 0.60%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.25% 0.25%
-------- --------
Total Annual Fund Operating Expenses 0.85% 1.10%
======== ========
Expense Reimbursement/Waiver (0.10%) (0.10%)
======== ========
Net Expenses** 0.75% 1.00%
======== ========
Examples
1 Year $87 $112
3 Years $271 $350
- ------------------------------------------------------------------------------------------
BRANDYWINE SMALL CAP VALUE PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.65% 0.65%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 5.82% 5.82%
-------- --------
Total Annual Fund Operating Expenses 6.47% 6.72%
======== ========
Expense Reimbursement/Waiver (5.62%) (5.62%)
======== ========
Net Expenses** 0.85% 1.10%
======== ========
25
<PAGE>
Examples
1 Year $642 $666
3 Years $1,899 $1,964
5 Years $3,118 $3,218
10 Years $6,014 $6,170
BATTERYMARCH INTERNATIONAL EQUITY PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.65% 0.65%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.40% 0.40%
-------- --------
Total Annual Fund Operating Expenses 1.05% 1.30%
======== ========
Expense Reimbursement/Waiver (0.05%) (0.05%)
======== ========
Net Expenses** 1.00% 1.25%
======== ========
Examples
1 Year $107 $132
3 Years $334 $412
BATTERYMARCH EMERGING MARKETS PORTFOLIO
Institutional Class Financial Intermediary Class
------------------- ----------------------------
Shareholder Fees
(Fees paid directly from your investment) None None
Annual Fund Operating Expenses
(Expenses deducted from Portfolio assets)
Management Fees 0.65% 0.65%
Distribution (12b-1) Fees* None 0.25%
Other Expenses 0.85% 0.85%
-------- --------
Total Annual Fund Operating Expenses 1.50% 1.75%
======== ========
Expense Reimbursement/Waiver (0.05%) (0.05%)
======== ========
Net Expenses** 1.45% 1.70%
======== ========
Examples
1 Year $153 $178
3 Years $474 $551
</TABLE>
*The 12b-1 fees shown in the tables reflect the amount to which the
Directors have currently limited payments under the Portfolios'
Distribution Plans. Pursuant to each Portfolio's Distribution Plan, the
Directors may increase the 12b-1 fees to 0.40% of average net assets
without shareholder approval. As a result of the 12b-1 fees, long-term
shareholders of the Financial Intermediary Class may pay more than the
economic equivalent of the maximum sales charge permitted by the National
Association of Securities Dealers, Inc.
**Reflects the Manager's contractual obligation to limit Portfolio expenses
through March 31, 2000.
"Other expenses" are based on annualized actual expenses for the one year
period (or since inception, if shorter) ended March 31, 1999 for the
Western Asset Limited Duration Portfolio, Western Asset Intermediate
Portfolio, Western Asset Core Portfolio, Western Asset Core Plus Portfolio,
Western Asset Non-U.S. Fixed Income Portfolio, LM Value Institutional
Portfolio and Brandywine SmallCap Value Portfolio. "Other Expenses" for the
other Portfolios are based on estimated amounts for the current fiscal
year.
26
<PAGE>
MANAGEMENT OF THE PORTFOLIOS
General
LMIFA I and LMIFA II are open-end management investment companies comprised of a
variety of separate investment portfolios. LMIFA I was incorporated in Maryland
on May 16, 1990. LMIFA II was incorporated in Maryland on January 13, 1998.
Board of Directors
The business affairs of LMIFA I and LMIFAII are managed under the direction of a
Board of Directors for each corporation, and the Directors of each corporation
are responsible for generally overseeing the conduct of the relevant Portfolio's
business. Information about the Directors and executive officers may be found in
the relevent SAI.
Each Board of Directors has retained the Manager and the Advisers to manage the
Portfolios' affairs, furnish a continuing investment program for the Portfolios
and make investment decisions on their behalf, subject to such policies as the
Directors may determine.
Manager, Advisers and Portfolio Managers
The Portfolios are managed by the Manager. Each Portfolio pays the Manager a
monthly fee based on the average net assets of the Portfolio at the following
annual rates (shown prior to any waivers or reimbursements):
<TABLE>
<CAPTION>
Annual Percentage of
Portfolio Average Net Assets
--------- ------------------
<S> <C> <C>
Western Asset Money Market Portfolio 0.20%
Western Asset Government Money Market Portfolio 0.20%
Western Asset Limited Duration Portfolio 0.35%
Western Asset Intermediate Portfolio 0.40%
Western Asset Intermediate Plus Portfolio 0.40%
Western Asset Core Portfolio 0.45%
Western Asset Core Plus Portfolio 0.45%
Western Asset High Yield Portfolio 0.55%
Western Asset Non-U.S. Fixed Income Portfolio 0.45%
Western Asset Global Strategic Income Portfolio 0.45%
Western Asset Enhanced Equity Portfolio 0.55%
LM Value Institutional Portfolio 0.60%
LM Special Investment Institutional Portfolio 0.60%
LM Total Return Institutional Portfolio 0.60%
Brandywine Small Cap Value Portfolio 0.65%
Batterymarch International Equity Portfolio 0.65%
Batterymarch Emerging Markets Portfolio 0.65%
</TABLE>
The Manager is a Maryland corporation formed on February 20, 1998 and is a
wholly owned subsidiary of Legg Mason, Inc., a financial services holding
company. The Manager's address is 100 Light Street, Baltimore, Maryland 21202.
In order to assist in carrying out its investment advisory responsibilities, the
Manager has retained the Advisers to render advisory services to the Portfolios.
The Manager pays the fees of the Advisers.
27
<PAGE>
The Manager pays a Portfolio's Adviser a monthly fee based on the average net
assets of the Portfolio at the following annual rates:
<TABLE>
<CAPTION>
Portfolio Advisers Adviser Fee
--------- -------- -----------
<S> <C> <C> <C>
Western Asset Money Market Portfolio Western Asset 0.15%
Western Asset Government Money Market Portfolio Western Asset 0.15%
Western Asset Limited Duration Portfolio Western Asset 0.30%
Western Asset Intermediate Portfolio Western Asset 0.35%
Western Asset Intermediate Plus Portfolio Western Asset/WAGM 0.35%
Western Asset Core Portfolio Western Asset 0.40%
Western Asset Core Plus Portfolio Western Asset/WAGM 0.40%
Western Asset High Yield Portfolio Western Asset 0.50%
Western Asset Non-U.S. Fixed Income Portfolio WAGM 0.40%
Western Asset Global Strategic Income Portfolio Western Asset/WAGM 0.40%
Western Asset Enhanced Equity Portfolio Western Asset 0.50%
LM Value Institutional Portfolio LMFA 0.55%
LM Special Investment Institutional Portfolio LMFA 0.55%
LM Total Return Institutional Portfolio LMFA 0.55%
Brandywine Small Cap Value Portfolio Brandywine 0.60%
Batterymarch International Equity Portfolio Batterymarch 0.60%
Batterymarch Emerging Markets Portfolio Batterymarch 0.60%
</TABLE>
LMFA. LMFA, founded in 1982, acts as adviser or manager to eighteen investment
company portfolios which had aggregate assets under management of approximately
$14 billion as of March 31, 1999. LMFA's address is 100 Light Street, Baltimore,
Maryland 21202. LMFA is a subsidiary of Legg Mason, Inc.
Brandywine. Brandywine, established in 1986 and now a wholly owned subsidiary of
Legg Mason, Inc., acts as investment adviser to institutional accounts, such as
corporate pension plans, mutual funds and endowment funds, as well as to
individual investors. Total assets under management by Brandywine were
approximately $7 billion as of March 31, 1999. The address of Brandywine is
Three Christina Centre, Suite 1200, 201 N. Walnut Street, Wilmington, Delaware
19801.
Batterymarch. Batterymarch, founded in 1969 and now a wholly owned subsidiary of
Legg Mason, Inc., acts as investment adviser to institutional accounts, such as
corporate pension plans, mutual funds and endowment funds, as well as to
individual investors. Total assets under management by Batterymarch were
approximately $4.5 billion as of March 31, 1999. The address of Batterymarch is
200 Clarendon Street, Boston, Massachusetts 02116.
Western Asset. Western Asset, established in 1971 and now a wholly owned
subsidiary of Legg Mason, Inc., acts as investment adviser to institutional
accounts, such as corporate pension plans, mutual funds and endowment funds, as
well as to individual investors. Total assets under management by Western Asset
were approximately $49 billion as of March 31, 1999. The address of Western
Asset is 117 East Colorado Boulevard, Pasadena, CA 91105.
WAGM. WAGM, a wholly owned subsidiary of Legg Mason, Inc., acts as investment
adviser to institutional accounts, such as corporate pension plans, mutual funds
and endowment funds, as well as to individual investors. Total assets under
management by WAGM were approximately $3 billion as of March 31, 1999. The
address of WAGM is 155 Bishopsgate, London, England.
Expense Limitations
As reflected in the tables contained in the Fees and Expenses section, the
Manager has, until March 31, 2000, contractually agreed to waive its fees and/or
reimburse each Portfolio in any month to the extent a Portfolio's expenses
(exclusive of taxes, interest, deferred organization expenses, 12b-1 fees,
brokerage and extraordinary expenses) for any class exceed during that month the
annual rate set forth in the applicable table under the heading "Net Expenses".
Any amounts waived or reimbursed in a particular fiscal year will be subject to
repayment by a Portfolio to the Manager to the extent that from time to time
during the next three fiscal years the repayment will not cause a Portfolio's
expenses to exceed the limit, if any, agreed to by the Manager at that time.
28
<PAGE>
Portfolio Managers
The names and business experience for each portfolio manager for the past five
years are set forth in the following chart.
<TABLE>
<CAPTION>
MANAGER AND BUSINESS EXPERIENCE
PORTFOLIO (PAST FIVE YEARS)
<S> <C> <C>
LM Value Institutional Portfolio William H. Miller, III is a portfolio manager and President of LMFA. Mr. Miller has
been employed by LMFA as a portfolio manager since 1982.
- ------------------------------------------------------------------------------------------------------------------------------------
LM Special Investment Institutional Portfolio William H. Miller, III (see above)
- ------------------------------------------------------------------------------------------------------------------------------------
LM Total Return Institutional Portfolio Nancy T. Dennin is a portfolio manager and Senior Vice President of LMFA. Ms. Dennin
has been employed by LMFA since 1985 and has served as a portfolio manager or co-
manager for over six years.
- ------------------------------------------------------------------------------------------------------------------------------------
Brandywine Small Cap Value Portfolio Henry F. Otto is a senior portfolio manager at Brandywine. Mr. Otto has been employed
by Brandywine as a portfolio manager and analyst since 1987. Steven M. Tonkovich is a
portfolio manager and analyst at Brandywine. Mr. Tonkovich has been employed by
Brandywine as a portfolio manager and analyst since 1989.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Neither Western Asset, nor WAGM nor Batterymarch employs individual portfolio
managers to determine the investments of a Portfolio. Instead, the day-to-day
management of the various Portfolios' investments will be the responsibility of
the Western Asset investment strategy group, the WAGM investment strategy group,
the Batterymarch emerging markets team, or the Batterymarch developed markets
(EAFE) team, as the case may be.
Distributors
Legg Mason Wood Walker, Incorporated ("LMWW") is the distributor of each
Portfolio's shares. LMWW pays certain expenses in connection with the offering
of shares of each Portfolio, including any compensation to its financial
advisors, the printing and distribution of prospectuses, SAIs and periodic
reports used in connection with the offering to prospective investors, and
expenses relating to any supplementary sales literature or advertising. The
Portfolios bear the expenses of preparing, setting in type and mailing the
prospectuses, SAIs and periodic reports to existing shareholders.
Arroyo Seco, Inc. ("Arroyo Seco"), a wholly owned subsidiary of Western Asset,
is also authorized to offer the shares of the LMIFA I Portfolios for sale to its
customers. The Portfolios make no payments to Arroyo Seco in connection with the
offer or sale of their shares, and Arroyo Seco does not collect any commissions
or other fees from customers in connection with the offer or sale of the
Portfolios' shares.
Portfolio Transactions
Each Portfolio's Adviser places all orders for the purchase and sale of
portfolio investments with brokers or dealers selected by it in its discretion.
It will seek the best price and execution of each Portfolio's orders. However,
the Adviser may pay higher commission rates than the lowest available when it
believes it is reasonable to do so in light of the value of brokerage and
research services provided by the broker effecting the transaction. The Adviser
may also consider sales of shares of the Portfolio (or other portfolios or other
funds managed by it or its affiliates, to the extent permitted by applicable
law) in selecting broker-dealers to execute Portfolio transactions. The
Portfolios may use LMWW, among others, as broker for agency transactions in
listed and over-the-counter securities at commission rates and under
circumstances consistent with the policy of best execution.
Some securities considered by an Adviser for purchase by a Portfolio may also be
appropriate for other clients served by the Adviser. To the extent the Portfolio
and such other clients purchase the same security, transactions in such security
will be allocated among the Portfolio and such other clients in a manner
considered fair and reasonable by the Adviser.
29
<PAGE>
Expenses
Each Portfolio pays its share of all expenses that are not assumed by the
Manager, the Adviser or other parties, including Directors', auditing, legal,
custodial, transfer agency and distribution fees (which are in turn allocated to
the Financial Intermediary Class of shares).
PURCHASE OF SHARES
The Portfolios offer two classes of shares: Institutional Class and Financial
Intermediary Class. Shares in the Financial Intermediary Class bear a 12b-1 fee.
See "Distribution Plans" below for more information.
Initial Investment
Prior to or concurrent with the initial purchase of shares in any Portfolio,
each investor must open an account for that Portfolio by completing and signing
an Application and mailing it to LM Institutional Advisors, Inc. at the
following address: P.O. Box 17635, Baltimore, Maryland 21297-1635. The
Portfolios have established minimum investment criteria that vary depending upon
which class of shares you wish to purchase. For Institutional Class shares,
investors must have at least $50 million in assets and invest in the aggregate
at least $1 million in the Portfolios. For Financial Intermediary Class shares,
investors must have at least $30 million in assets and invest in the aggregate
at least $1 million in the Portfolios. The Portfolios reserve the right to
revise the minimum investment requirement and may waive it at their sole
discretion.
A purchase order, together with payment in one of the forms described in the
following paragraphs, received by Boston Financial Data Services (the "Transfer
Agent" or "BFDS") prior to the close of regular trading on the Exchange
(ordinarily 4:00 p.m., Eastern time) ("close of the Exchange") will be effected
at that day's net asset value. An order received after the close of the Exchange
will generally be effected at the net asset value determined on the next
business day. However, orders received by certain retirement plans and other
financial intermediaries by the close of the Exchange and communicated to the
Transfer Agent by 9:30 a.m., Eastern time, on the following business day will be
effected at the net asset value determined on the prior business day.
Purchases of shares can be made by wiring federal funds to State Street Bank and
Trust Company. Purchases of shares of the Western Asset Money Market Portfolio
or the Western Asset Government Money Market Portfolio may ONLY be made by
federal funds wire. Before wiring federal funds, the investor must first
telephone the Portfolio at 1-888-425-6432 to receive instructions for wire
transfer. On the telephone, the following information will be required:
shareholder name; name of the person authorizing the transaction; shareholder
account number; name of the Portfolio and class of shares to be purchased;
amount being wired; and name of the wiring bank.
Funds should be wired through the Federal Reserve System to:
State Street Bank and Trust Company
ABA #011-000-028
DDA#99046096
LM Institutional Fund Advisors [insert name of Portfolio]
[Insert your account name and number]
The wire should state that the funds are for the purchase of shares of a
specific Portfolio and include the account name and number. With respect to
Portfolios whose policy is to declare dividends daily, if a purchase order for
shares is received prior to 12:00 noon, Eastern time, and payment in federal
funds is received by the Transfer Agent by the close of the federal funds wire
on the day the purchase order is received, dividends will accrue starting that
day. If a purchase order is received after 12:00 noon, Eastern time, and payment
in federal funds is received by the Transfer Agent by the close of the federal
funds wire on the day the purchase order is received, or as otherwise agreed to
by the relevant Portfolio, the order will be effected at that day's net asset
value, but dividends will not begin to accrue until the following business day.
30
<PAGE>
Shares may also be purchased and paid for by the contribution of eligible
portfolio securities, subject in each case to approval by the Manager. Approval
will depend on, among other things, the nature and quality of the securities
offered and the current needs of the Portfolio in question. Securities offered
in payment for shares will be valued in the same way and at the same time the
Portfolio values its portfolio securities for purposes of determining net asset
value. (See "Net Asset Value" below.) Investors who wish to purchase Portfolio
shares through the contribution of securities should contact the Portfolio at
1-888-425-6432 for instructions. Investors should also realize that at the time
of contribution they may be required to recognize a gain or loss for tax
purposes on securities contributed. The Portfolio has full discretion to reject
any securities offered as payment for shares. As described below, each Portfolio
may offer Financial Intermediary Class shares that are offered primarily through
financial intermediaries. Each Portfolio may pay financial intermediaries for
their services out of that class's assets pursuant to the class's distribution
plan or otherwise. Legg Mason and its affiliates (including the Manager and the
Advisers) may also from time to time, at their own expense, make payments to
financial intermediaries that sell shares of the Portfolios or to other parties
in connection with the sale of shares. If investors effect transactions through
a broker or agent, investors may be charged a fee by that broker or agent.
Any shares purchased or received as a distribution will be credited directly to
the investor's account.
Additional Investments
Additional investments may be made at any time at the relevant net asset value
for that class by following the procedures outlined above. Investors should
always furnish a shareholder account number when making additional purchases.
Other Purchase Information
Purchases will be made in full and fractional shares. In the interest of economy
and convenience, certificates for shares will not be issued.
Each Portfolio and LMWW reserves the right, in its sole discretion, to suspend
the offering of shares or to reject any purchase order, in whole or in part,
when, in the judgment of management, such suspension or rejection is in the best
interests of the Portfolio; to waive the minimum initial investment for certain
investors; and to redeem shares if information provided in the Application
should prove to be incorrect in any manner judged by a Portfolio to be material
(e.g., in a manner such as to render the shareholder ineligible to purchase
shares of a Portfolio). A Portfolio may suspend the offering of shares at any
time and resume it at any time thereafter.
Shares of the Portfolios may not be qualified or registered for sale in all
States. Prospective investors should inquire as to whether shares of a
particular Portfolio are available for offer and sale in their State of
residence. Shares of the Portfolio may not be offered or sold in any State
unless registered or qualified in that jurisdiction or unless an exemption from
registration or qualification is available.
Purchases and sales of Portfolio shares should be made for long-term investment
purposes only. Each Portfolio reserves the right to restrict purchases of shares
(including exchanges) when it determines that a pattern of frequent purchases
and sales made in response to short-term fluctuations in share price appears
evident.
Retirement Plans
Shares of the Portfolios are available for purchase by retirement plans,
including 401(k) plans, 403(b) plans and Individual Retirement Accounts
("IRAs"). The administrator of a plan or employee benefits office can provide
participants or employees with detailed information on how to participate in the
plan and how to elect a Portfolio as an investment option. Participants in a
retirement or savings plan may be permitted to elect different investment
options, alter the amounts contributed to the plan, or change how contributions
are allocated among investment options in accordance with the plan's specific
provisions. The plan administrator or employee benefits office should be
consulted for details. For questions about participant accounts, participants
should contact their employee benefits office, the plan administrator, or the
organization that provides recordkeeping services for the plan. Investors who
purchase shares through retirement plans should be aware that the plan
administrator may aggregate purchase and redemption orders of participants in
the plan. Therefore, there may be a delay between the time the investor places
an order with the plan administrator and the time the order is forwarded to the
Transfer Agent for execution.
31
<PAGE>
Account Registration Changes
Changes in registration or account privileges may be made in writing to the
Portfolio. Signature guarantees may be required. See "Signature Guarantee"
below. All correspondence must include the account number and must be sent to:
LM Institutional Advisors, Inc.
P.O. Box 17635
Baltimore, Maryland 21297-1635
- --------------------------------------------------------------------------------
DISTRIBUTION PLANS
The Board of Directors has adopted Distribution Plans pursuant to Rule 12b-1
under the 1940 Act with respect to shares of the Financial Intermediary Class of
each Portfolio. Under the terms of each Plan, a Portfolio is permitted to pay,
out of the assets of the Financial Intermediary Class of the Portfolio, in an
amount up to 0.40% on an annual basis of the average daily net assets of that
class, LMWW, financial intermediaries and other parties that provide services in
connection with or are otherwise involved in the distribution of shares or
administration of plans or programs that use Portfolio shares as their funding
medium, and to reimburse certain other expenses and payments. Payments under the
Plans are currently limited to 0.25% (or 0.10% in the case of the Western Asset
Government Money Market Portfolio and the Western Asset Money Market Portfolio)
of average daily net assets. For more information regarding the Plans and their
terms, see the SAI for each of LMIFA I and LMIFA II.
- --------------------------------------------------------------------------------
REDEMPTION OF SHARES
Portfolio shares may be redeemed through three methods: (1) by sending a written
request for redemption to LM Institutional Advisors, Inc. at P.O. Box 17635,
Baltimore, Maryland 21297-1635; (2) by calling the Portfolio at 1-888-425-6432;
or (3) by wire communication with the Transfer Agent. In each case, the investor
should first notify the Portfolio at 1-888-425-6432 of the intention to redeem.
No charge is made for redemptions. Shareholders who wish to be able to redeem by
telephone or wire communication must complete an authorization form in advance.
Redemptions over $10,000,000 may be initiated by telephone, but must be
confirmed in writing prior to processing. With respect to telephone redemptions
or transfers, the Transfer Agent will process orders based on instructions from
a shareholder, or any person claiming to act as his or her representative, who
can provide it with his or her account registration and address as it appears on
its records. The Transfer Agent will employ these and other reasonable
procedures to confirm that instructions communicated by telephone are genuine;
if it fails to employ reasonable procedures, the Transfer Agent may be liable
for any losses due to unauthorized or fraudulent instructions.
Upon receipt of a request for redemption as described below (a request "in good
order") before the close of the Exchange on any day when the Exchange is open,
the Transfer Agent will redeem Portfolio shares at that day's net asset value
per share. Requests for redemption received by the Transfer Agent after the
close of the Exchange will be executed at the net asset value next determined.
However, orders received by certain retirement plans and other financial
intermediaries by the close of the Exchange and communicated to the Transfer
Agent by 9:30 a.m., Eastern time, on the following business day will be effected
at the net asset value determined on the prior business day. The Portfolios may
refuse to effect redemption requests during periods permitted by federal
securities laws.
Requests for redemption should indicate:
1) The number of shares or dollar amount to be redeemed and the investor's
shareholder account number;
2) The investor's name and the names of any co-owner of the account, using
exactly the same name or names used in establishing the account;
3) Proof of authorization to request redemption on behalf of any co-owner
of the account (please contact the Portfolio for further details); and
4) The name, address, and account number to which the redemption payment
should be sent.
Payment of the redemption price normally will be made by wire one business day
after receipt of a redemption request in good order. However, each Portfolio
reserves the right to postpone the payment date when the Exchange is closed,
when trading is restricted, or during other periods as permitted by federal
securities laws, or to take up to seven days to make payment upon
32
<PAGE>
redemption if the Portfolio involved could be adversely affected by immediate
payment. Redemption proceeds may also be paid in kind at the discretion of the
Portfolio. Shareholders who receive a redemption in kind may incur costs to
dispose of such securities.
Other supporting legal documents, such as copies of the trust instrument or
power of attorney, may be required from corporations or other organizations,
fiduciaries or persons other than the shareholder of record making the request
for redemption or repurchase. If you have a question concerning the sale or
redemption of shares, please contact the Portfolio by calling 1-888-425-6432.
Any Portfolio may elect to close any shareholder account when the current value
of the account is less than $1 million due to redemptions or exchanges by the
shareholder by redeeming all of the shares in the account and mailing the
proceeds to the investor. If a Portfolio elects to redeem the shares in an
account, the shareholder will be notified that the account is below $1 million
and will be allowed 30 days in which to make an additional investment in order
to avoid having the account closed. Shares will be redeemed at the net asset
value calculated on the day of redemption. Any Portfolio may change the $1
million minimum account balance from time to time without notice to
shareholders.
Signature Guarantee
When a signature guarantee is called for, the shareholder should have "Signature
Guaranteed" stamped under his or her signature and guaranteed by any of the
following entities: U.S. banks, foreign banks having a U.S. correspondent bank,
credit unions, savings associations, U.S. registered dealers and brokers,
municipal securities dealers and brokers, government securities dealers and
brokers, national securities exchanges, registered securities associations and
clearing agencies (each an "Eligible Guarantor Institution"). Each Portfolio and
its agents reserve the right to reject any signature guarantee pursuant to
written signature guarantee standards or procedures, which may be revised in the
future to permit them to reject signature guarantees from Eligible Guarantor
Institutions that do not, based on credit guidelines, satisfy such written
standards or procedures. Any Portfolio may change the signature guarantee
requirements from time to time without prior notice to shareholders.
- --------------------------------------------------------------------------------
EXCHANGE PRIVILEGE
Shareholders in any Portfolio may exchange their shares for shares of the same
class of any of the other Portfolios, provided that the shares of that class are
being offered at the time of the proposed exchange. Investments by exchange
among any of the Portfolios are made at the per share net asset values next
determined after the order for exchange is received in good order.
The exchange privilege is not intended as a vehicle for short-term trading.
Excessive exchange activity may interfere with portfolio management and have an
adverse effect on all shareholders. In order to limit excessive exchange
activity and in other circumstances where a Portfolio believes doing so would be
in its best interest, the Portfolio reserves the right to revise or terminate
the exchange privilege without notice to the extent permitted by applicable law,
limit the amount or number of exchanges or reject any exchange. For further
information concerning the exchange privilege, or to make an exchange, please
contact the Portfolio at 1-888-425-6432.
- --------------------------------------------------------------------------------
NET ASSET VALUE
Net asset value per share of each class of shares is determined daily for each
Portfolio as of the close of regular trading on the Exchange (normally 4:00
p.m., Eastern time), on every day that the Exchange is open, by subtracting the
Portfolio's liabilities attributable to a given class of shares from its total
assets attributable to the class and dividing the result by the number of shares
of that class outstanding. Net asset value will not be determined on days on
which the Exchange is closed.
Except for the Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio, portfolio securities and other assets for
which market quotations are readily available are valued at current market
value. Current market value means the last sale price of the day for a
comparable position, or, in the absence of any such sales, the mean between
representative bid and asked prices obtained from a quotation reporting system.
Securities with remaining maturities of 60 days or less are generally valued at
amortized cost. Fixed income securities, including those to be purchased under
firm commitment agreements, are normally valued on the basis of quotations
obtained from brokers and dealers or pricing services which take into account
appropriate factors such as institutional-size trading in similar groups of
securities, yield, quality, coupon rate,
33
<PAGE>
maturity, type of issue, trading characteristics and other market data. Certain
fixed income securities for which daily market quotations are not readily
available may be valued with reference to fixed income securities whose prices
are more readily available and whose durations are comparable to those of the
securities being valued.
Other assets and securities for which no quotations are readily available are
valued at fair value as determined in good faith by the Directors or persons
acting at their direction. The values of foreign securities quoted in foreign
currencies are translated into U.S. dollars at current exchange rates or at such
other rates as the Directors or persons acting at their direction may determine
in computing net asset value.
Because of time zone differences, foreign exchanges and securities markets will
usually be closed prior to the time of the closing of the Exchange and values of
foreign investments will be determined as of the earlier closing of such
exchanges and securities markets. However, events affecting the values of such
foreign securities may occasionally occur between the earlier closings of such
exchanges and securities markets and the closing of the Exchange which will not
be reflected in the computation of the net asset value. If an event materially
affecting the value of such foreign securities occurs during such period, then
such securities will be valued at fair value as determined in good faith by the
Directors or persons acting at their direction.
The Western Asset Money Market Portfolio and the Western Asset Government Money
Market Portfolio each attempts to maintain a per share net asset value of $1.00
by using the amortized cost method of valuation as permitted by SEC Rule 2a-7.
Neither Portfolio can guarantee that the net asset value will always remain at
$1.00 per share.
- --------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
The LMIFA I Portfolios (other than the Western Asset Money Market and Western
Asset Government Money Market Portfolios), the LM Value Institutional Portfolio
and the LM Total Return Institutional Portfolio declare and pay dividends
quarterly out of their net investment income, if available, for that quarter.
The Western Asset Money Market Portfolio and the Western Asset Government Money
Market Portfolio declare as a dividend at the close of regular trading on the
Exchange each business day, to shareholders of record as of 12:00 noon, Eastern
Time, that day, substantially all of their net investment income since the prior
business day's dividend. The Western Asset Money Market Portfolio and the
Western Asset Government Money Market Portfolio pay dividends monthly. All other
Portfolios declare and pay dividends annually out of their net investment
income, if available, for that year. Distributions of net realized capital gains
are made annually.
Shareholders may elect to receive dividends and distributions in one of four
ways:
1) Receive both dividends and other distributions in shares of the same
class of the distributing Portfolio;
2) Receive dividends in cash and other distributions in shares of the same
class of the distributing Portfolio;
3) Receive dividends in shares of the same class of the distributing
Portfolio and other distributions in cash; or
4) Receive both dividends and other distributions in cash.
If no election is made, both dividends and other distributions are credited to a
shareholder's Portfolio account in shares (of the same class as the shares
already held) at the net asset value of the shares determined as of the close of
the Exchange on the reinvestment date.
For the Western Money Market Portfolio and the Western Asset Government Money
Market Portfolio, reinvestment of dividends and other distributions occurs on
the payment date. A shareholder who redeems all shares in the Western Asset
Money Market Portfolio or the Western Asset Government Money Market Portfolio
will receive all dividends and other distributions declared for that monthly
cycle prior to the redemption date (i.e., all dividends and other distributions
from the first day of that monthly cycle, if invested on that first day, to the
date of the redemption). For the other Portfolios, reinvestment occurs on the
ex-dividend date. An election to receive dividends or other distributions in
cash rather than additional shares may be made by notifying the Portfolio in
writing.
The Directors reserve the right to revise the dividend policy or postpone the
payment of dividends if warranted in their judgment due to unusual
circumstances, such as an unexpected large expense, loss or fluctuation in net
asset value.
34
<PAGE>
- --------------------------------------------------------------------------------
TAX INFORMATION
Each Portfolio intends to qualify or continue to qualify as a "regulated
investment company" for federal income tax purposes and to meet all other
requirements necessary for it to be relieved of federal taxes on income and
gains it distributes to shareholders. Each Portfolio will distribute
substantially all its net investment income and net realized capital gains to
its shareholders on a current basis.
Distributions from a Portfolio (whether paid in cash or reinvested in shares of
the Portfolio) will be taxable to shareholders (other than IRAs, other qualified
retirement plans and other tax-exempt investors) as ordinary income to the
extent derived from the Portfolio's investment income and net short-term gains.
Portfolio distributions of net capital gains (that is, the excess of net gains
from capital assets held for more than one year over net losses from capital
assets held for not more than one year) will be taxable as long-term capital
gain.
Special tax rules apply to investments through defined contributions plans and
other tax-qualified plans. Shareholders should consult their tax adviser to
determine the suitability of shares of a Portfolio as an investment through such
plans and the precise effect of an investment on their particular tax situation.
To the extent distributions consist of interest from securities of the U.S.
Government and certain of its agencies and instrumentalities, they may be exempt
from state and local income taxes. Interest from obligations that are merely
guaranteed by the U.S. Government or one of its agencies, such as mortgage
participation certificates guaranteed by GNMA, generally is not entitled to this
exemption. Although there is no assurance that any such state and local
exemptions will be available, shareholders will be advised of the portion of
Portfolio distributions that might qualify for such an exemption.
A Portfolio's investments in foreign securities may be subject to withholding
taxes at the source on dividend or interest payments. In that case, a
Portfolio's yield on those securities would be decreased.
If at the end of a Portfolio's fiscal year more than 50% of the value of its
total assets represents securities of foreign corporations, the Portfolio may
make an election to treat any foreign taxes paid by it as paid by its
shareholders. In this case, shareholders who are U.S. citizens, U.S.
corporations and, in some cases, U.S. residents generally will be required to
include in U.S. taxable income their pro rata share of such taxes, but may then
generally be entitled to claim a foreign tax credit or deduction (but not both)
for their share of such taxes. A shareholder's ability to claim a foreign tax
credit or deduction in respect of foreign taxes paid by a Portfolio may be
subject to certain limitations (including a holding period requirement,
applicable to both a Portfolio and its shareholders, imposed by the Taxpayer
Relief Act of 1997).
A Portfolio's transactions in foreign currencies and hedging activities may give
rise to ordinary income or loss to the extent such income or loss results from
fluctuations in value of the foreign currency concerned. In addition, such
activities will likely produce a difference between book income and taxable
income. This difference may cause a portion of a Portfolio's income
distributions to constitute a return of capital for tax purposes or require a
Portfolio to make distributions exceeding book income to qualify as a regulated
investment company for tax purposes.
Investment in an entity that qualifies as a "passive foreign investment company"
under the Internal Revenue Code of 1986 (the "Code") could subject a Portfolio
to a U.S. federal income tax or other charge on certain "excess distributions"
with respect to the investment, and on the proceeds from disposition of the
investment. A Portfolio may make an election to mark the gains (and to a limited
extent losses) in such investments "to the market" as though it had sold and
repurchased its holdings in those passive foreign investment companies on the
last day of the Portfolio's taxable year.
Early each year, each Portfolio will notify its shareholders of the amount and
tax status of distributions paid during that year.
The foregoing is a summary of certain federal income tax consequences of
investing in a Portfolio. Shareholders are urged to consult their tax advisers
with respect to the effects of this investment on their particular tax situation
(including possible liability for state and local taxes).
35
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand each
Portfolio's recent financial performance for the past five years or, if shorter,
since the inception of the Portfolio's operations. Certain information reflects
financial results for a single Portfolio share. The total returns represent the
rate that an investor would have earned or lost on an investment in the
Portfolios, assuming reinvestment of all dividends and distributions. This
information has been derived from the financial statements of LMIFA I and LMIFA
II, which have been audited by PricewaterhouseCoopers LLP and Ernst & Young LLP,
respectively. Their reports and the Portfolios' financial statements are
included in the Portfolios' annual reports to shareholders, which are available
upon request.
- --------------------------------------------------------------------------------
Western Asset Core Portfolio
Financial Highlights(A)
Contained below is per share operating performance data for a share of common
stock outstanding throughout each period shown, total investment return, ratios
to average net assets and other supplemental data. This information has been
derived from information in the financial statements.
<TABLE>
<CAPTION>
For the
For the Nine Months For the
Year Ended Ended Years Ended June 30,
March 31, March 31, -----------------------------------------------
1999 1998(B) 1997 1996 1995 1994
---- ------ ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $ 11.59 $ 11.28 $ 11.05 $ 11.22 $ 10.50 $ 11.66
-------- -------- -------- -------- -------- --------
Net investment income(C) 0.64 0.49 0.70 0.67 0.69 0.57
Net realized and unrealized gain (loss)
on investments, options and futures (0.01) 0.49 0.19 (0.14) 0.72 (0.63)
-------- -------- -------- -------- -------- --------
Total from investment operations 0.63 0.98 0.89 0.53 1.41 (0.06)
Distributions to shareholders from:
Net investment income (0.65) (0.53) (0.65) (0.66) (0.69) (0.61)
Net realized gain on investments (0.56) (0.14) (0.01) (0.04) -- (0.49)
-------- -------- -------- -------- -------- --------
Total distributions (1.21) (0.67) (0.66) (0.70) (0.69) (1.10)
-------- -------- -------- -------- -------- --------
Net asset value, end of period $ 11.01 $ 11.59 $ 11.28 $ 11.05 $ 11.22 $ 10.50
======== ======== ======== ======== ======== ========
Total return(C) 5.61% 8.91%(D) 8.27% 4.86% 14.12% (0.89)%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses(C) 0.50% 0.50%(E) 0.50% 0.50% 0.50% 0.50%
Net investment income(C) 5.7% 6.0%(E) 6.4% 6.3% 7.0% 6.0%
Portfolio turnover rate 484.3% 226.9%(E) 384.8% 266.0% 257.9% 272.5%
Net assets, end of period (in thousands) $685,489 $617,676 $508,353 $453,699 $336,774 $205,959
</TABLE>
- ---------------------
(A) All per share figures reflect the 10 for 1 stock split effective May 29,
1998.
(B) The year end for the Western Asset Core Portfolio has been changed from June
30 to March 31.
(C) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.50%. In the absence of this limitation, the ratio of expenses to average
net assets would have been 0.50% for the year ended March 31, 1999 and the
nine months ended March 31, 1998, and 0.50%, 0.53%, 0.53% and 0.58% for the
years ended June 30, 1997, 1996, 1995 and 1994, respectively.
(D) Not annualized
(E) Annualized
36
<PAGE>
Western Asset Core Plus Portfolio
Financial Highlights
Contained below is per share operating performance data for a share of common
stock outstanding through the period shown, total investment return, ratios to
average net assets and other supplemental data. This information has been
derived from information in the financial statements.
July 8, 1998(A)
to
March 31, 1999
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 10.00
--------
Net investment income(B) 0.34
Net realized and unrealized gain (loss) on investments,
options, futures and foreign currency transactions (0.08)
--------
Total from investment operations 0.26
--------
Distributions to shareholders from:
Net investment income (0.22)
Net realized gain on investments (0.07)
--------
Total distributions (0.29)
--------
Net asset value, end of period $ 9.97
========
Total return(B) 2.58%(C)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses(B) 0.50%(D)
Net investment income(B) 5.4%(D)
Portfolio turnover rate 565.7%(D)
Net assets, end of period (in thousands) $119,646
- ---------------------
(A) Commencement of operations
(B) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.50%. In the absence of this limitation, the ratio of expenses to average
net assets would have been 0.65% for the period ended March 31, 199.
(C) Not annualized
(D) Annualized
37
<PAGE>
Western Asset Intermediate Portfolio
Financial Highlights(A)
Contained below is per share operating performance data for a share of common
stock outstanding through the period shown, total investment return, ratios to
average net assets and other supplemental data. This information has been
derived from information in the financial statements.
<TABLE>
<CAPTION>
Financial
Institutional Class Intermediary Class
----------------------------------------------------------- -----------------
For the For the Nine For the Period
Year Ended Months Ended For the Years Ended
March 31, March 31, Ended June 30, March 31,
------------------------------
1999 1998(F) 1997 1996 1995 1999(G)
------------------- ---------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $ 10.85 $ 10.72 $ 10.48 $ 10.74 $ 10.00 $10.60
-------- -------- -------- -------- -------- --------
Net investment income 0.58(B) 0.46(B) 0.55(B) 0.54(B) 0.39(B) 0.12(C)
Net realized and unrealized
gain (loss) on investments,
options and futures 0.06 0.23 0.30 (0.01) 0.60 (0.11)
-------- -------- -------- -------- -------- --------
Total from investment operations 0.64 0.69 0.85 0.53 0.99 0.01
-------- -------- -------- -------- -------- --------
Distributions to shareholders from:
Net investment income (0.57) (0.46) (0.54) (0.54) (0.24) --
Net realized gain on investments (0.30) (0.10) (0.07) (0.25) (0.01) --
-------- -------- -------- -------- -------- --------
Total distributions (0.87) (0.56) (0.61) (0.79) (0.25) --
-------- -------- -------- -------- -------- --------
Net asset value, end of period $ 10.62 $ 10.85 $ 10.72 $ 10.48 $ 10.74 $10.61
======== ======== ======== ======== ======== ========
Total return 6.01% 6.59%(D) 8.32% 5.15% 10.08% 0.09%(D)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses 0.45%(B) 0.45%(B,E) 0.45%(B) 0.50%(B) 0.50%(B) 0.70%(C,E)
Net investment income 5.5%(B) 5.8%(B,E) 6.3%(B) 6.3%(B) 6.1%(B) 5.2%(C,E)
Portfolio turnover rate 389.6% 401.4%(E) 419.3% 841.3% 764.5% 389.6%(E)
Net assets, end of period
(in thousands) $314,534 $293,531 $224,497 $66,079 $20,313 $3,792
</TABLE>
- ---------------------
(A) All per share figures for the Institutional Class reflect the 10 for 1 stock
split effective May 29, 1998.
(B) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.50% until August 5, 1996 and 0.45% thereafter. In the absence of this
limitation, the ratio of expenses to average net assets would have been
0.48% for the year ended March 31, 1999, 0.52% for the nine months ended
March 31, 1998, and 0.55%, 1.03% and 1.60% for the years ended June 30,
1997, 1996 and 1995, respectively.
(C) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.70%. In the absence of this limitation, the ratio of expenses to average
net assets would have been 0.73% for the period January 7, 1999
(commencement of operations) to March 31, 1999.
(D) Not annualized
(E) Annualized
(F) The year end for the Western Asset Intermediate Portfolio has been changed
from June 30 to March 31.
(G) For the period January 7, 1999 (commencement of operations) to March 31,
1999
38
<PAGE>
Western Asset Limited Duration Portfolio
Financial Highlights(A)
Contained below is per share operating performance data for a share of common
stock outstanding throughout each period shown, total investment return, ratios
to average net assets and other supplemental data. This information has been
derived from information in the financial statements.
<TABLE>
<CAPTION>
For the For the For the May 1, 1996(C)
Year Ended Nine Months Ended Year Ended to
March 31, 1999 March 31, 1998(B) June 30, 1997 June 30, 1996
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $ 10.27 $ 10.24 $ 10.08 $ 10.00
-------- -------- -------- -------
Net investment income(D) 0.69 0.43 0.60 0.09
Net realized and unrealized gain (loss) on
investments, options and futures (0.19) 0.11 0.13 (0.01)
-------- -------- -------- -------
Total from investment operations 0.50 0.54 0.73 0.08
-------- -------- -------- -------
Distributions to shareholders from:
Net investment income (0.64) (0.47) (0.53) --
Net realized gain on investments (0.19) (0.04) (0.04) --
-------- -------- -------- -------
Total distributions (0.83) (0.51) (0.57) --
-------- -------- -------- -------
Net asset value, end of period $ 9.94 $ 10.27 $ 10.24 $ 10.08
======== ======== ======== =======
Total return(D) 4.96% 5.42%(E) 7.42% 0.76%(E)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses(D) 0.40% 0.40%(F) 0.41% 0.50%(F)
Net investment income(D) 6.1% 5.8%(F) 6.2% 5.6%(F)
Portfolio turnover rate 321.3% 373.0%(F) 435.5% 1,042%(F)
Net assets, end of period (in thousands) $26,101 $50,371 $26,537 $16,110
</TABLE>
- ---------------------
(A) All per share figures reflect the 10 for 1 stock split effective May 29,
1998.
(B) The year end for the Western Asset Limited Duration Portfolio has been
changed from June 30 to March 31.
(C) Commencement of operations
(D) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.50% until August 31, 1996, and 0.40% thereafter. In the absence of this
limitation, the ratio of expenses to average net assets would have been
0.75% for the year ended March 31, 1999, 0.95% for the nine months ended
March 31, 1998, 1.21% for the year ended June 30, 1997, and 0.80% for the
period ended June 30, 1996.
(E) Not annualized
(F) Annualized
39
<PAGE>
Western Asset Non-U.S. Fixed Income Portfolio
Financial Highlights
Contained below is per share operating performance data for a share of common
stock outstanding through the period shown, total investment return, ratios to
average net assets and other supplemental data. This information has been
derived from information in the financial statements.
July 15, 1998(A)
to
March 31, 1999
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 10.00
--------
Net investment income(B) 0.30
Net realized and unrealized gain (loss) on investments,
futures, foreign currency transactions and assets and
liabilities denominated in foreign currencies 0.31
--------
Total from investment operations 0.61
--------
Distributions to shareholders from:
Net investment income (0.20)
Net realized gain on investments (0.20)
--------
Total distributions (0.40)
--------
Net asset value, end of period $ 10.21
========
Total return(B) 5.81%(C)
RATIO/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses(B) 0.55%(D)
Net investment income(B) 4.1%(D)
Portfolio turnover rate 388.0%(D)
Net assets, end of period (in thousands) $ 65,358
- ---------------------
(A) Commencement of operations
(B) Net of advisory fees waived pursuant to a voluntary expense limit of 0.55%.
In the absence of this limitation, the ratio of expenses to average net
assets would have been 0.85% for the period ended March 31, 1999.
(C) Not annualized
(D) Annualized
40
<PAGE>
LM Value Institutional Portfolio
Financial Highlights
Contained below is per share operating data for a share of common stock
outstanding, total investment return, ratios to average net assets and other
supplemental data. This information has been derived from information provided
in the financial statements.
<TABLE>
<CAPTION>
Institutional Class Financial Intermediary Class
September 22, 1998(A) October 22, 1998(A)
to to
March 31, 1999 March 31,1999
-------------- -------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $10.00 $10.71
Net investment income 0.04(B) 0.03(C)
Net realized and unrealized gain
on investments 5.83 5.14
------- -------
Total from investment operations 5.87 5.17
------- -------
Distributions to shareholders from
net investment income (0.02) (0.02)
------- -------
Net asset value, end of period $15.85 $15.86
------- -------
Total return 58.81%(D) 48.32%(D)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets
Expenses 0.75%(B,E) 1.00%(C,E)
Net investment income 0.84%(B,E) 0.43%(C,E)
Portfolio turnover rate 28.6%(E) 28.6%(E)
Net assets, end of period
(in thousands) $115,798 $18,751
</TABLE>
- ---------------------
(A) Commencement of operations.
(B) Net of fees waived and reimbursements made by LMIA in excess of a voluntary
expense limitation of .75% until July 31, 1999. If no fees had been waived
by LMIA, the annualized ratio of expenses to average daily net assets for
the period would have been 1.08%.
(C) Net of fees waived and reimbursements made by LMIA in excess of a voluntary
expense limitation of 1.00% until July 31, 1999. If no fees had been waived
by LMIA, the annualized ratio of expenses to average daily net assets for
the period would have been 1.33%.
(D) Not annualized
(E) Annualized
41
<PAGE>
Brandywine Small Cap Value Portfolio
Financial Highlights
Contained below is per share operating data for a share of common stock
outstanding, total investment return, ratios to average net assets and other
supplemental data. This information has been derived from information provided
in the financial statements.
August 17, 1998(A)
to
March 31, 1999
--------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $10.00
Net investment income(B) 0.04
Net realized and unrealized gain (loss) on investments (1.47)
------
Total from investment operations (1.43)
------
Distributions to shareholders from net investment income (0.02)
------
Net asset value, end of period $ 8.55
======
Total Return (14.38%)(C)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses(B) 0.85%(D)
Net investment income(B) 0.71%(D)
Portfolio turnover rate 45.05%(D)
Net assets, end of period $1,945,597
- -------------------------------
(A) Commencement of operations
(B) Net of fees waived by LMIA and expenses reimbursed pursuant to a voluntary
expense limitation of 0.85% until July 31, 1999. If no fees had been waived
and reimbursed by LMIA, the annualized ratio of expenses to average daily
net asset for the period would have been 6.47%.
(C) Not annualized
(D) Annualized
42
<PAGE>
APPENDIX A: PRIOR PERFORMANCE OF LMIFA II'S ADVISERS' OTHER ACCOUNTS
The LM Value Institutional Portfolio and the Brandywine Small Cap Value
Portfolio have performance results only for the period from September 22, 1998,
and August 17, 1998, respectively, to June 30, 1999. The other four Portfolios
of LMIFA II have not yet commenced operations and have no performance record of
their own. However, the Advisers of LMIFA II have managed other client accounts
that have investment objectives and policies that are similar, but not
necessarily identical, to those of the Portfolios that they manage.
Representative investment performance for these accounts is stated below. The
investment performance is shown on an annual total return basis, with returns
for periods of less than one year not annualized, and on an average annual total
return basis. The performance information is provided through June 30, 1999.
The prior performance information shown is in two categories and reflects the
performance of either: (1) composites of certain of the Adviser's separately
managed accounts and (2) SEC-registered, open-end investment companies. In each
case, the account or accounts have investment objectives and policies
substantially similar (although not necessarily identical) to those of the
relevant Portfolio and were managed throughout the periods shown using
investment styles and strategies substantially similar (although not necessarily
identical) to those of the relevant Portfolio. To the extent a composite of
accounts is shown, the composite includes all of the fully-discretionary,
fee-paying accounts managed by such Adviser during the periods shown using
investment objectives, policies and strategies substantially similar (although
not necessarily identical) to those of the relevant Portfolio.
The performance information for composites has been adjusted to give effect to
the Portfolios' estimated fees and expenses, before waivers and reimbursements,
for the Financial Intermediary Class shares as shown in the tables beginning on
page 20. The performance information for composites assumes reinvestment of all
dividends and proceeds from capital transactions and has been prepared in
accordance with the Performance Presentation Standards established by the
Association for Investment Management and Research ("AIMR standards"), except
for the deduction of estimated fees and expenses as noted above. The performance
results would be more favorable if they had been adjusted for estimated fees and
expenses of the Institutional Class shares of the Portfolios. Accounts included
in composites are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on each of the
Portfolios by the Investment Company Act of 1940 (the "1940 Act") or the Code.
The performance results for these accounts might have been adversely affected
had the accounts been subject to these requirements, restrictions and
limitations.
Performance for SEC-registered, open-end investment companies is calculated
using the SEC's standardized total return formula, which is based upon the
change in value of an assumed initial investment of $1,000 from the beginning
through the end of a period and assumes reinvestment of all dividends and other
distributions. For periods of more than one year, the result is then annualized
and expressed as a percentage of the initial investment, and includes the effect
of operating expenses, including advisory fees. Information about the investment
objectives, policies, expenses and net assets of each of the investment
companies follows the performance information.
The method for calculating performance for the composites produces a different
result than if the performance were calculated using the SEC's method for
calculating the total return of an open-end investment company.
A Portfolio's expenses, timing of purchases and sales of portfolio securities,
timing and availability of cash flows, cash positions (which are typically
greater for open-end investment companies than for separate accounts), and
brokerage commissions are some of the factors that might cause performance
results of the Portfolio to vary from that of the composites and/or investment
companies shown. In particular, the large infusions of cash that are typically
associated with the commencement of operations of new mutual funds such as the
Portfolios, as well as differences in the amount of assets held by the
Portfolios as opposed to the accounts and/or investment companies shown below,
can affect the ability and the manner in which security positions are
accumulated or liquidated, and thus may cause a Portfolio's performance to vary
from that of the composites and/or investment companies shown below.
As noted above, the investment objectives, policies, styles and strategies of
each Portfolio are not necessarily identical to those of the relevant composites
and/or investment companies shown below. Again, for these and other reasons, the
performance of the Portfolios will vary from that of the composites and/or
investment companies.
43
<PAGE>
Prior Performance of Accounts Similar to the LM Value Institutional Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 of
all accounts managed by LMFA and Legg Mason Capital Management, Inc. ("LMCM"),
an affiliate of LMFA that shares investment personnel with LMFA, that are
substantially similar to the Porfolio is shown below. The benchmark index to
which the accounts are compared is the S&P 500 Index. The S&P 500 Index is an
unmanaged index representing the performance of 500 companies selected by S&P.
Although used as a benchmark, the Index's performance may not be comparable to
the accounts' performance because, unlike the performance of the accounts, the
Index's performance has not been adjusted for any fees or expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1999 42.41 22.77
1998 39.39 30.16
1997 53.32 34.71
1996 29.69 26.00
1995 28.64 26.07
1994 5.72 1.41
1993 14.94 13.63
1992 19.53 13.41
1991 -4.32 7.39
1990 5.74 16.49
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1 Year 42.41 22.77
3 Year 44.92 29.12
5 Year 38.40 27.87
10 Year 22.26 18.78
The number of accounts included in the composite has ranged from 1 to 12 over
the relevant period and the aggregate assets of the accounts has ranged from
$637 million to $12.4 billion over the period. One of the accounts included in
the composite is a registered investment company. In addition, all of the fully
discretionary accounts of LMCM with assets greater than $25 million are included
in the composite after a period of three months and after the account becomes
fully invested. Accounts included in the composite are generally not subject to
the diversification requirements, specific tax restrictions and investment
limitations imposed on the Portfolio by the 1940 Act or the Code. The
performance results for these accounts might have been adversely affected had
the accounts been subject to these requirements, restrictions and limitations.
These potential differences do not adversely affect the determination that the
accounts included in this composite are managed in a substantially similar
manner to the Portfolio.
44
<PAGE>
The investment performance for the period from July 1, 1989 to June 30, 1999 for
the Primary Class shares of the Legg Mason Value Trust ("Value Trust"), which
has been advised by LMFA since its inception, is shown below.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1999 41.65 22.77
1998 38.48 30.16
1997 52.16 34.71
1996 28.64 26.00
1995 27.59 26.07
1994 4.86 1.41
1993 13.95 13.63
1992 18.48 13.41
1991 -5.20 7.39
1990 4.80 16.49
- --------------------------------------------------------------------------------
Average Annual Returns
Period Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1 Year 41.65 22.77
3 Year 43.98 29.12
5 Year 37.41 27.87
10 Year 21.29 18.78
Value Trust, which commenced operations on April 16, 1982, is a diversified
open-end investment company. Value Trust's investment objective is long-term
growth of capital. Value Trust invests primarily in equity securities that, in
the Adviser's opinion, offer the potential for capital growth. The Adviser
follows a value discipline in selecting securities, and therefore seeks to
purchase securities at large discounts to the Adviser's assessment of their
intrinsic value. Intrinsic value, according to the Adviser, is the value of the
company measured, to different extents depending on the type of company, on
factors such as, but not limited to, the discounted value of its projected
future free cash flows, the company's ability to earn returns on capital in
excess of its cost of capital, private market values of similar companies, the
value of its assets, and the costs to replicate the business. Qualitative
factors, such as an assessment of the company's products, competitive
positioning, strategy, industry economics and dynamics, regulatory frameworks
and more, are also important. Securities may be undervalued due to uncertainty
arising from the availability of accurate information, economic growth and
change, changes in competitive conditions, technological change, changes in
government policy or geo-political dynamics, and more. The Adviser takes a
long-term approach to investing, generally characterized by long holding periods
and low portfolio turnover. Value Trust generally invests in companies with
market capitalizations greater than $5 billion, but may invest in companies of
any size.
Value Trust may also invest in debt securities of companies having one or more
of the above characteristics. Value Trust may invest up to 25% of its net assets
in long-term debt securities. Up to 10% of its total assets may be invested in
debt securities rated below investment grade.
For temporary purposes, or when cash is temporarily available, Value Trust may
invest without limit in investment grade, short-term debt instruments, including
government, corporate and money market securities.
As of June 30, 1999, Value Trust had approximately $11.9 billion in assets. For
its fiscal year ended March 31, 1999, the Primary Class shares of Value Trust
had a total expense ratio of 1.69%.
45
<PAGE>
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS BEEN IN OPERATION ONLY SINCE SEPTEMBER 22, 1998. THE PERFORMANCE
INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE PERFORMANCE OF THE
PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER THAN THAT SHOWN.
Prior Performance of a Registered Investment Company Similar to the LM Special
Investment Institutional Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 for
the Primary Class shares the Legg Mason Special Investment Trust ("Special
Investment Trust") is shown below. LMFA has served as the Adviser of the Special
Investment Trust since its inception. The benchmark index to which Special
Investment Trust is compared is the S&P 500 Index. The S&P 500 Index is an
unmanaged index representing the performance of 500 companies selected by S&P.
Although used as a benchmark, the Index's performance may not be comparable to
Special Investment Trust's performance since, unlike the performance of Special
Investment Trust, the Index's performance has not been adjusted for any fees or
expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1999 27.18 22.77
1998 22.29 30.16
1997 22.52 34.17
1996 25.89 26.00
1995 8.85 26.07
1994 4.97 1.41
1993 25.72 13.63
1992 12.34 13.41
1991 14.37 7.39
1990 10.96 16.49
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1 Year 27.18 22.77
3 Year 23.98 29.12
5 Year 21.16 27.87
10 Year 17.25 18.78
Special Investment Trust, which commenced operations on December 30, 1985, is a
diversified open-end investment company. Special Investment Trust's investment
objective is capital appreciation. Special Investment Trust invests primarily in
equity securities, and securities convertible into equity securities, of
companies whose market capitalizations are typically classified as small to
mid-sized. The Adviser defines small to mid-sized companies as those below the
top 500 U.S. companies in terms of market capitalization. It also invests in
"special situations" without regard to market capitalization. Special situations
are securities undergoing unusual or possibly one-time developments that, in the
opinion of the Adviser, make them attractive for investment. Such developments
may include actual or anticipated: sale or termination of an unprofitable part
of the company's business; change in the company's management or in management's
philosophy; a basic change in the industry in which the company operates;
introduction of new products or technologies; or the prospect or effect of
acquisition or merger activities.
46
<PAGE>
Special Investment Trust's Adviser follows a value discipline in selecting
securities, and therefore seeks to purchase securities at large discounts to the
Adviser's assessment of their intrinsic value. Intrinsic value, according to the
Adviser, is the value of the company measured, to different extents depending on
the type of company, on factors such as, but not limited to, the discounted
value of its projected future free cash flows, the company's ability to earn
returns on capital in excess of its cost of capital, private market values of
similar companies, the value of its assets, and the costs to replicate the
business. Qualitative factors, such as an assessment of the company's products,
competitive positioning, strategy, industry economics and dynamics, regulatory
frameworks and more, are also important. Securities may be undervalued due to
uncertainty arising from the availability of accurate information, economic
growth and change, changes in competitive conditions, technological change,
changes in government policy or geo-political dynamics, and more.
Special Investment Trust also invests in debt securities of companies having one
or more of the above characteristics. Special Investment Trust may invest up to
35% of its net assets in debt securities rated below investment grade. Special
Investment Trust may invest up to 20% of its total assets in securities of
companies involved in actual or anticipated reorganizations or restructurings.
For temporary defensive purposes, or when cash is temporarily available, Special
Investment Trust may invest without limit in investment grade, short-term debt
instruments, including government, corporate and money market securities.
As of June 30, 1999, Special Investment Trust had approximately $2.1 billion in
assets. For its fiscal year ended March 31, 1999, the Primary Class shares of
Special Investment Trust had a total expense ratio of 1.84%.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN.
THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE
PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER
THAN THAT SHOWN.
Prior Performance of a Registered Investment Company Similar to the LM Total
Return Institutional Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 for
the Primary Class shares the Legg Mason Total Return Trust, Inc. ("Total Return
Trust") is shown below. LMFA serves as Adviser to the Total Return Trust. The
benchmark index to which Total Return Trust is compared is the S&P 500 Index.
The S&P 500 Index is an unmanaged index representing the performance of 500
companies selected by S&P. Although used as a benchmark, the Index's performance
may not be comparable to Total Return Trust's performance since, unlike the
performance of Total Return Trust, the Index's performance has not been adjusted
for any fees or expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1999 3.45 22.77
1998 23.31 30.16
1997 38.14 34.71
1996 23.28 26.00
1995 11.83 26.07
1994 4.69 1.41
1993 14.66 13.63
1992 25.09 13.41
1991 2.45 7.39
1990 -0.84 16.49
47
<PAGE>
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) S&P 500 Performance (%)
- --------------------------------------------------------------------------------
1 Year 3.45 22.77
3 Year 20.78 29.12
5 Year 19.43 27.87
10 Year 14.00 18.78
Total Return Trust, which commenced operations on November 21, 1985, is a
diversified open-end investment company. Total Return Trust's investment
objective is to obtain capital appreciation and current income in order to
achieve an attractive total investment return consistent with reasonable risk.
Total Return Trust invests primarily in securities that, in the Adviser's
opinion, offer the potential for long-term capital growth and attractive current
income. Total Return Trust invests primarily in common stocks, debt securities,
and securities convertible into common stocks, but is not limited to these types
of securities. Total Return Trust may invest in securities that do not pay
current income but do, in the Adviser's opinion, offer prospects for capital
appreciation and/or future income. The Adviser follows a value discipline in
selecting securities, and therefore seeks to purchase securities at large
discounts to the Adviser's assessment of their intrinsic value. Intrinsic value,
according to the Adviser, is the value of the company measured, to different
extents depending on the type of company, on factors such as, but not limited
to, the discounted value of its projected future free cash flows, the company's
ability to earn returns on capital in excess of its cost of capital, private
market values of similar companies, the value of its assets, and the costs to
replicate the business. Qualitative factors, such as an assessment of the
company's products, competitive positioning, strategy, industry economics and
dynamics, regulatory frameworks and more, are also important. Securities may be
undervalued due to uncertainty arising from the availability of accurate
information, economic growth and change, changes in competitive conditions,
technological change, changes in government policy or geo-political dynamics,
and more. The Total Return Trust may invest in companies of any size.
Total Return Trust may invest in money market securities for temporary defensive
purposes or when cash is temporarily available. Consistent with the investment
objective, Total Return Trust may also invest in debt securities when the
Adviser believes the return on certain debt securities may equal or exceed the
return on equity securities. Total Return Trust may invest in debt securities of
any maturity of both foreign and domestic issuers without regard to rating, and
may invest its assets in such securities without regard to a percentage limit.
The Adviser currently anticipates that under normal market conditions, the fund
will invest no more than 50% of its total assets in intermediate-term and
long-term debt securities and no more than 5% of its total assets in debt
securities not rated investment grade.
As of June 30, 1999, Total Return Trust had approximately $631 million in
assets. For its fiscal year ended March 31, 1999, the Primary Class shares of
Total Return Trust had a total expense ratio of 1.87%.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN.
THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE
PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER
THAN THAT SHOWN.
48
<PAGE>
Prior Performance of Accounts Similar to the Brandywine Small Cap Value
Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 of
all accounts managed by Brandywine that are substantially similar to the
Portfolio is shown below. The benchmark index to which the accounts are compared
is the Russell 2000 Value Index. The Russell 2000 Value Index is an unmanaged
index representing the performance of the 2000 smallest of the 3000 largest
U.S.-domiciled corporations with lower price-to-book ratios and lower forecasted
growth values. Although used as a benchmark, the Index's performance may not be
comparable to the accounts' performance since, unlike the performance of the
accounts, the Index's performance has not been adjusted for any fees or
expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Russell 2000
Year Ended June 30, Account Performance (%) Value Performance (%)
- --------------------------------------------------------------------------------
1999 -4.17 -5.70
1998 23.28 19.90
1997 32.88 28.25
1996 19.43 21.12
1995 17.11 14.63
1994 6.48 7.60
1993 22.77 30.83
1992 18.25 20.35
1991 13.43 1.93
1990 -2.63 -2.55
- --------------------------------------------------------------------------------
Average Annual Total Return
Russell 2000
Period Ended June 30, Account Performance (%) Value Performance (%)
- --------------------------------------------------------------------------------
1 Year -4.17 -5.70
3 Year 16.22 13.18
5 Year 17.03 15.02
10 Year 14.13 12.98
The number of accounts included in the composite has ranged from 2 to 21 over
the relevant period and the aggregate assets of the accounts has ranged from $56
million to $2 billion over the period. One of the accounts included in the
composite is a registered open-end investment company. Accounts included in the
composite are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Portfolio by
the 1940 Act or the Code. The performance results for these accounts might have
been adversely affected had the accounts been subject to these requirements,
restrictions and limitations. In addition, the accounts included in the
composite have invested in so-called "micro" cap stocks to a greater extent than
the Portfolio is likely to. These potential differences do not adversely affect
the determination that the accounts included in this composite are managed in a
substantially similar manner to the Portfolio.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS BEEN IN OPERATION ONLY SINCE AUGUST 17, 1998. THE PERFORMANCE
INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE PERFORMANCE OF THE
PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER THAN THAT SHOWN.
49
<PAGE>
Prior Performance of Accounts Similar to the Batterymarch International Equity
Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 of
all accounts managed by Batterymarch that are substantially similar to the
Portfolio is shown below. The benchmark index to which the accounts are compared
is the MSCI Europe Australia & Far East Index ("MSCI EAFE"). The MSCI EAFE is an
unmanaged index representing the performance of share prices of approximately
1100 companies listed on stock exchanges around the world. Twenty countries are
included in the Index. Although used as a benchmark, the Index's performance may
not be comparable to the accounts' performance since, unlike the performance of
the accounts, the Index's performance has not been adjusted for any fees or
expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) MSCI EAFE Performance (%)
- --------------------------------------------------------------------------------
1999 -5.93 7.92
1998 11.72 6.38
1997 18.51 13.16
1996 14.24 13.62
1995 1.20 1.95
1994 17.32 17.30
1993 6.60 20.70
1992 8.26 -0.31
1991 -15.96 -11.23
1990 25.04 3.53
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) MSCI EAFE Performance (%)
- --------------------------------------------------------------------------------
1 Year -5.93 7.92
3 Year 7.59 9.12
5 Year 7.57 8.52
10 Year 7.44 6.92
The number of accounts included in the composite has ranged from 4 to 11 over
the relevant period and the aggregate assets of the accounts has ranged from
$705 million to $1.4 billion over the period. One of the accounts included in
the composite is a registered investment company. Accounts included in the
composite are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Portfolio by
the 1940 Act or the Code. The performance results for these accounts might have
been adversely affected had the accounts been subject to these requirements,
restrictions and limitations. These potential differences do not adversely
affect the determination that the accounts included in this composite are
managed in a substantially similar manner to the Portfolio.
The investment performance for the period from February 17, 1995 to June 30,
1999 for the Primary Class shares the Legg Mason International Equity Trust
("International Equity Trust"), which has been advised by Batterymarch since its
inception, is shown below.
50
<PAGE>
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) MSCI EAFE Performance (%)
- --------------------------------------------------------------------------------
1999 -7.03 7.92
1998 5.73 6.38
1997 18.74 13.16
1996 15.90 13.62
1995
(Inception 2/17/95) 4.00 6.08
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) MSCI EAFE Performance (%)
- --------------------------------------------------------------------------------
1 Year -7.03 7.92
3 Year 5.29 9.12
Since Inception
(2/17/95) 8.13 11.16
International Equity Trust, which commenced operations on February 17, 1995, is
a diversified open-end investment company. International Equity Trust's
investment objective is maximum long-term total return. International Equity
Trust's Adviser currently intends to invest substantially all of the fund's
assets in non-U.S. equity securities. The primary focus of the Adviser is stock
selection, with a secondary focus on country allocation. The Adviser uses a
bottom-up, quantitative stock selection process for the developed markets
portion of the fund's portfolio. The cornerstone of this process is a
proprietary stock selection model that ranks the 2,800 stocks in the fund's
principal investable universe by relative attractiveness on a daily basis. The
quantitative factors within this model are intended to measure growth, value,
fundamental expectations and technical indicators (i.e., supply and demand).
Because the same quantitative factors are not effective across all markets due
to individual market characteristics, the adviser adjusts the stock selection
model to include factors that its research indicates are effective, eliminating
factors that are not valid in a particular market. The Adviser runs the stock
selection model and re-balances the portfolio daily, purchasing all stocks
ranked "buys" by the model and selling all stocks ranked "sells." Stocks are
sold when the original reason for purchase no longer pertains, the fundamentals
have deteriorated or portfolio re-balancing warrants.
Country allocation for the developed markets portion of the fund is based on
rankings generated by the Adviser's proprietary country model. The Adviser
examines securities from over 20 international stock markets, with emphasis on
several of the largest: Japan, United Kingdom, France, Canada and Germany.
International Equity Trust may invest up to 35% of its total assets in emerging
market securities. The Adviser's investment strategy for the emerging markets
portion of the fund represents a distinctive combination of tested quantitative
methodology and traditional fundamental analysis. The emerging markets
allocation focuses on higher-quality, dominant companies which the adviser
believes to have strong growth prospects and reasonable valuations. Country
allocation for the emerging markets portion of the portfolio also combines
quantitative and fundamental approaches.
International Equity Trust's investment portfolio will normally be diversified
across a broad range of industries and across a number of countries, consistent
with the objective of maximum total return. The adviser may also seek to enhance
portfolio returns through active currency hedging strategies. More than 25% of
International Equity Trust's total assets may be denominated in a single
currency or invested in securities of issuers located in a single country.
When cash is temporarily available, or for temporary defensive purposes, when
the adviser believes such action is warranted by abnormal market or economic
situations, International Equity Trust may invest without limit in cash and U.S.
dollar-denominated money market instruments, including repurchase agreements of
domestic issuers. Such securities will be rated investment grade or, if unrated,
will be determined by the fund's adviser to be investment grade.
51
<PAGE>
As of June 30, 1999, International Equity Trust had approximately $253 million
in assets. For its fiscal year ended December 31, 1998, the Primary Class shares
of International Equity Trust had a total expense ratio of 2.14%.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN.
THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE
PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER
THAN THAT SHOWN.
Prior Performance of Accounts Similar to the Batterymarch Emerging Markets
Portfolio.
The investment performance for the period from January 1, 1994 to June 30, 1999
of all accounts managed by Batterymarch that are substantially similar to the
Portfolio is shown below. The benchmark index to which the accounts are compared
is the MSCI Emerging Markets Free Index with Gross Dividends ("MSCI EMF"). The
MSCI EMF is an unmanaged index representing the performance of a market weighted
aggregate of 26 individual emerging country indexes and takes into account local
and market restrictions on share ownership by foreigners. Although used as a
benchmark, the Index's performance may not be comparable to the accounts'
performance since, unlike the performance of the accounts, the Index's
performance has not been adjusted for any fees or expenses.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) MSCI EMF Performance (%)
- --------------------------------------------------------------------------------
1999 25.56 28.71
1998 -34.01 -39.08
1997 19.99 12.82
1996 10.61 8.47
1995 -7.51 0.01
1994
(Inception 1/1/94) -10.82 -9.04
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) MSCI EMF Performance (%)
- --------------------------------------------------------------------------------
1 Year 25.56 28.71
3 Year -0.19 -4.00
5 Year 0.42 -0.83
Since Inception
(1/1/94) -2.41 -2.70
The number of accounts included in the composite has ranged from 1 to 4 over the
relevant period and the aggregate assets of the accounts has ranged from $43
million to $1 billion over the period. One of the accounts included in the
composite is a registered investment company. Accounts included in the composite
are generally not subject to the diversification requirements, specific tax
restrictions and investment limitations imposed on the Portfolio by the 1940 Act
or the Code. The performance results for these accounts might have been
adversely affected had the accounts been subject to these requirements,
restrictions and limitations. These potential differences do not adversely
affect the determination that the accounts included in this composite are
managed in a substantially similar manner to the Portfolio.
52
<PAGE>
The investment performance for the period from May 28, 1996 to June 30, 1999 for
the Primary Class shares of the Legg Mason Emerging Markets Trust ("Emerging
Markets Trust"), which has been advised by Batterymarch since its inception, is
shown below.
- --------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30, Account Performance (%) MSCI EMF Performance (%)
- --------------------------------------------------------------------------------
1999 24.82 28.71
1998 -34.42 -39.08
1997 27.41 12.82
1996
(Inception 5/28/96) 0.20 -0.45
- --------------------------------------------------------------------------------
Average Annual Total Return
Period Ended June 30, Account Performance (%) MSCI EMF Performance (%)
- --------------------------------------------------------------------------------
1 Year 24.82 28.71
Since Inception
(5/28/96) 1.44 -3.71
Emerging Markets Trust, which commenced operations on May 28, 1996, is a
diversified open-end investment company. Emerging Markets Trust's investment
objective is long-term capital appreciation. Emerging Markets Trust's Adviser
intends to invest substantially all of the fund's assets in equity securities
and convertible securities of emerging market issuers.
Emerging Markets Trust intends to invest in Asia, Latin America, the Indian
Subcontinent, Southern and Eastern Europe, the Middle East and Africa, although
it may not invest in all these markets at all times and may not invest in any
particular market when it deems investment in that country or region to be
inadvisable.
More than 25% of Emerging Market's Trust's total assets may be denominated in a
single currency or invested in securities of issuers located in a single
country.
The Adviser focuses on higher-quality, dominant emerging markets companies which
the Adviser believes to have strong growth prospects and reasonable valuations,
selected from a principal investable universe of approximately 1,000 stocks. The
Adviser's emerging markets investment strategy represents a distinctive
combination of quantitative methodology and traditional fundamental analysis.
Traditional "on-the-ground" fundamental research is combined by the Adviser with
tested quantitative valuation disciplines in those markets where reliable data
is available. In determining country allocation, the Adviser also merges
quantitative and fundamental approaches. In markets with reliable historical
data, buy and sell decisions are driven by a combination of quantitative
valuations and the Adviser's fundamental opinions. Stocks are sold when the
original reason for purchase no longer pertains, the fundamentals have
deteriorated or portfolio re-balancing warrants.
When cash is temporarily available, or for temporary defensive purposes, when
the Adviser believes such action is warranted by abnormal market or economic
situations, the fund may invest without limit in cash and U.S.
dollar-denominated money market instruments, including repurchase agreements of
domestic issuers. Such securities will be rated investment grade or, if unrated,
will be determined by the adviser to be investment grade.
As of June 30, 1999, Emerging Markets Trust had approximately $74 million in
assets. For its fiscal year ended December 31, 1998, the Primary Class shares of
Emerging Markets Trust had a total expense ratio of 2.50% (after fee waivers;
2.78% in the absence of such waivers).
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO,
WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN.
THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE
PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER
THAN THAT SHOWN.
53
<PAGE>
LM INSTITUTIONAL FUND ADVISORS I
LM INSTITUTIONAL FUND ADVISORS II
Custodian
State Street Bank and Trust Co.
P.O. Box 1713
Boston, Massachusetts 02105
Transfer Agent and Shareholder Servicing Agent
Boston Financial Data Services
P.O. Box 953
Boston, Massachusetts 02103
Counsel
Ropes & Gray
One International Place
Boston, Massachusetts 02110
Independent Auditors
PricewaterhouseCoopers LLP
250 W. Pratt Street
Baltimore, Maryland 21201
Ernst & Young LLP
2001 Market Street
Philadelphia, PA 19103
Distributors
Legg Mason Wood Walker, Incorporated
100 Light Street P.O. Box 1476
Baltimore, Maryland 21203-1476
Arroyo Seco, Inc.
117 East Colorado Boulevard
Pasadena, California 91105
For investors who want more information about LM Institutional Fund Advisors I,
Inc. ("LMIFA I") and LM Institutional Fund Advisors II, Inc. ("LMIFA II"), the
following documents are available upon request.
Annual Reports
Annual and semi-annual reports provide additional information about the
Portfolios' investments. In the annual report, you will also find a discussion
of the market conditions and investment strategies that significantly affected
the performance of a Portfolio during the last fiscal year.
Statement of Additional Information
The SAI of each of LMIFA I and LMIFA II contains additional detailed information
about LMIFA I and LMIFA II and is incorporated by reference into (legally part
of) this prospectus.
Investors can receive free copies of these materials, request other information
about the Portfolios and make shareholder inquiries by calling 1-888-425-6432.
Information about the Portfolios, including the SAI, can be reviewed and copied
at the SEC's public reference room in Washington, D.C. (phone 1-800-SEC-0330).
Reports and other information about the Portfolios are available on the SEC's
Internet site at http://www.sec.gov. Investors may also write to:SEC, Public
Reference Section, Washington,D.C. 20549-6009. A fee will be charged for making
copies.
The Investment Company Act of 1940 file numbers for LMIFA I and LMIFA II are
811-06110 and 811-8611, respectively.
<PAGE>
LM INSTITUTIONAL FUND ADVISORS I, INC. August 1, 1999
- --------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
LM Institutional Fund Advisors I, Inc. (the "Fund") is a no-load, open-end
management investment company. LM Institutional Fund Advisors I, Inc. currently
consists of eleven separate professionally managed investment portfolios. These
eleven portfolios are described in this Statement of Additional Information
("SAI"). Each of these portfolios is referred to herein as a "Portfolio".
This SAI is not a prospectus and should be read in conjunction with the
Prospectus for the Portfolios, dated August 1, 1999, which has been filed with
the Securities and Exchange Commission ("SEC"). Copies of the Portfolios'
Prospectus are available without charge from Legg Mason Wood Walker, Inc. at
1-800-822-5544.
<PAGE>
TABLE OF CONTENTS
Definitions 1
Additional Information About Investment Limitations and Policies 1
Additional Information About Securities, Investment Techniques 5
and Related Risks
Valuation of Portfolio Shares 24
Management of the Portfolios 25
Purchases and Redemptions 32
Exchange Privilege 33
Portfolio Transactions and Brokerage 33
Additional Tax Information 34
Other Information 35
Principal Holders of Securities 36
Financial Statements and Report of Independent Accountants 43
-i-
<PAGE>
DEFINITIONS
"Adviser" means the investment advisory firm that manages a Portfolio's assets.
Western Asset and WAGM are each Advisers.
"Code" means the Internal Revenue Code of 1986, as amended.
"Distributor" means the broker-dealer that is responsible for the distribution
or sale of the Fund's shares. Legg Mason is the Fund's Distributor. Arroyo
Secco, Inc. also serves as a Distributor to the Fund.
"Exchange" means the New York Stock Exchange.
"Fundamental Investment Limitation" means an investment limitation of a
Portfolio that may be changed only with the affirmative vote of the lesser of
(a) more than 50% of the outstanding shares of the relevant Portfolio or (b) 67%
or more of the shares of the relevant Portfolio present at a shareholders'
meeting if more than 50% of the outstanding shares of that Portfolio are
represented at the meeting in person or by proxy. Only those policies or
limitations expressly designated as such are fundamental investment limitations.
All other policies and restrictions may be changed without shareholder approval.
"Independent Director" means a Director of the Fund who is not an "interested
person" (as defined in the 1940 Act) of the Fund.
"Legg Mason" means Legg Mason Wood Walker, Inc.
"Manager" means LM Institutional Fund Advisors, Inc., 100 Light Street,
Baltimore, MD 21202.
"1940 Act" means the Investment Company Act of 1940, as amended.
"NRSROs" means nationally recognized (or foreign) statistical rating
organizations, including Moody's Investors Service, Inc. ("Moody's") and
Standard & Poor's ("S&P").
"Plan" means the Fund's Distribution and Shareholder Services Plan.
"SEC" means the Securities and Exchange Commission.
"12B-1 Director" means a Director of the Fund who is an Independent Director and
who has no direct or indirect financial interest in the operation of the Fund's
Plan or the Fund's Underwriting Agreement.
"WAGM" means Western Asset Global Management Limited, 155 Bishopsgate, London,
England. WAGM is the Adviser to the Western Asset Non-U.S. Fixed Income
Portfolio and to the non-U.S. portion of the Western Asset Intermediate Plus
Portfolio, the Western Asset Core Plus Portfolio, and the Western Asset Global
Strategic Income Portfolio.
"Western Asset" means Western Asset Management Company, 117 East Colorado
Boulevard, Pasadena, CA 91105. Western Asset is the Adviser to each Portfolio
other than the Western Asset Non-U.S. Fixed Income Portfolio and to the U.S.
portion of the Western Asset Global Strategic Income Portfolio.
ADDITIONAL INFORMATION ABOUT
INVESTMENT LIMITATIONS AND POLICIES
Each Portfolio has adopted certain fundamental investment limitations that are
set forth below.
The Western Asset Limited Duration Portfolio may not:
<PAGE>
(1) Borrow money or issue senior securities, except that it may borrow
from banks or enter into reverse repurchase agreements, provided that,
immediately after such borrowing, the total amount borrowed by the
Portfolio, including reverse repurchase agreements, does not exceed 33
1/3% of its total assets (including the amount borrowed) less
liabilities (other than the borrowings); and provided further that it
may enter into transactions in options, futures, options on futures and
forward foreign currency contracts as described in the Prospectus and
this Statement of Additional Information;
(2) Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the
Portfolio, except as may be necessary in connection with permitted
borrowings, provided that this limitation does not prohibit escrow,
collateral or margin arrangements in connection with the Portfolio's
use of options, futures contracts, options on futures contracts,
forward foreign currency contracts, when-issued securities or reverse
repurchase agreements;
(3) Invest more than 5% of its total assets (taken at market value) in
securities of any one issuer, or buy 10% or more of all the securities
of any one issuer, except that up to 25% of the Portfolio's total
assets may be invested without regard to this limitation, and provided
that this limitation does not apply to securities issued or guaranteed
by the U.S. Government, its agencies and instrumentalities;
(4) Purchase securities on margin, except for short-term credits
necessary for clearance of portfolio transactions and except that the
Portfolio may make margin deposits in connection with its use of
options, futures contracts, options on futures contracts and forward
foreign currency contracts;
(5) Invest 25% or more of its total assets (taken at market value) in
any one industry, provided that this limitation does not apply to
securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, or repurchase agreements thereon; and provided
further that, for purposes of this limitation, U.S. branches of foreign
banks are considered U.S. banks if they are subject to substantially
the same regulation as domestic banks, and foreign branches of U.S.
banks are considered U.S. banks if the domestic parent would be
unconditionally liable in the event that the foreign branch failed to
pay on the instruments for any reason;
(6) Purchase or sell commodities or commodity contracts, except that
the Portfolio may purchase or sell futures on fixed income instruments
and foreign currencies and options thereon, may engage in transactions
in foreign currencies and may purchase or sell options on securities
and on foreign currencies and forward foreign currency contracts;
(7) Underwrite securities of other issuers, except to the extent that,
in connection with the disposition of portfolio securities, the
Portfolio may be deemed an underwriter under federal securities laws;
(8) Make loans, except loans of portfolio securities and except to the
extent that the purchase of a portion of an issue of publicly
distributed notes, bonds or other evidences of indebtedness or deposits
with banks and other financial institutions may be considered loans;
(9) Purchase or sell real estate, provided that the Portfolio may
invest in securities secured by, or issued by companies that invest in,
real estate or interests therein, including real estate investment
trusts; or
(10) Invest in oil, gas or mineral-related programs or leases, provided
that the Portfolio may invest in securities issued by companies that
engage in such activities.
-2-
<PAGE>
The Western Asset Core Portfolio may not:
(1) Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the
Portfolio, except as may be necessary in connection with permitted
borrowings, provided that this limitation does not prohibit escrow,
collateral or margin arrangements in connection with the Portfolio's
use of options, futures contracts, options on futures contracts,
forward foreign currency contracts, when-issued securities or reverse
repurchase agreements;
(2) Invest more than 5% of its total assets (taken at market value) in
securities of any one issuer, or buy 10% or more of all the securities
of any one issuer, except that up to 25% of the Portfolio's total
assets may be invested without regard to this limitation, and provided
that this limitation does not apply to securities issued or guaranteed
by the U.S. Government, its agencies and instrumentalities;
(3) Purchase securities on margin, except for short-term credits
necessary for clearance of portfolio transactions and except that the
Portfolio may make margin deposits in connection with its use of
options, futures contracts, options on futures contracts and forward
foreign currency contracts;
(4) Invest 25% or more of its total assets (taken at market value) in
any one industry, provided that this limitation does not apply to
securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, or repurchase agreements thereon; and provided
further that, for purposes of this limitation, U.S. branches of foreign
banks are considered U.S. banks if they are subject to substantially
the same regulation as domestic banks, and foreign branches of U.S.
banks are considered U.S. banks if the domestic parent would be
unconditionally liable in the event that the foreign branch failed to
pay on the instruments for any reason;
(5) Purchase or sell commodities or commodity contracts, except that
the Portfolio may purchase or sell futures on fixed income instruments
and foreign currencies and options thereon, may engage in transactions
in foreign currencies and may purchase or sell options on securities
and on foreign currencies and forward foreign currency contracts;
(6) Underwrite securities of other issuers, except to the extent that,
in connection with the disposition of portfolio securities, the
Portfolio may be deemed an underwriter under federal securities laws;
(7) Purchase or sell real estate, provided that the Portfolio may
invest in securities secured by, or issued by companies that invest in,
real estate or interests therein, including real estate investment
trusts; or
(8) Invest in oil, gas or mineral-related programs or leases, provided
that the Portfolio may invest in securities issued by companies that
engage in such activities.
In addition, the Western Asset Core Portfolio may:
(9) Lend or borrow money or issue senior securities to the fullest
extent permitted by the 1940 Act, the rules or regulations thereunder
or applicable orders of the SEC, as such statute, rules, regulations or
orders may be amended from time to time.
Other than the Western Asset Core Portfolio and the Western Asset
Limited Duration Portfolio, each Portfolio may (except as noted below):
(1) lend or borrow money or issue senior securities to the fullest
extent permitted by the 1940 Act, the rules or regulations thereunder
or applicable orders of the SEC, as such statute, rules, regulations or
orders may be amended from time to time.
(2) not concentrate investments in a particular industry or group of
industries as concentration is defined under the 1940 Act, the rules or
regulations thereunder or applicable orders of the SEC, as such
statute, rules, regulations or orders may be amended from time to time.
Securities issued or guaranteed by the U.S. Government, or its agencies
or instrumentalities will not be considered to represent an industry.
(This does not apply to the Western Asset Money Market and Western
Asset Intermediate Portfolios.)
-3-
<PAGE>
(3) underwrite securities to the fullest extent permitted by the 1940
Act, the rules or regulations thereunder or applicable orders of the
SEC, as such statute, rules, regulations or orders may be amended from
time to time. (This does not apply to the Western Asset Money Market
and Western Asset Intermediate Portfolios.)
(4) purchase or sell commodities, commodities contracts, futures
contracts, options, forward contracts or real estate to the fullest
extent permitted by the 1940 Act, the rules or regulations thereunder
or applicable orders of the SEC, as such statute, rules, regulations or
orders may be amended from time to time.
In addition, the Western Asset Money Market Portfolio and the Western
Asset Intermediate Portfolio may not:
(5) Invest more than 5% of its total assets (taken at market value) in
securities of any one issuer, or buy 10% or more of all the securities
of any one issuer, except that up to 25% of the Portfolio's total
assets may be invested without regard to this limitation, and provided
that this limitation does not apply to securities issued or guaranteed
by the U.S. Government, its agencies and instrumentalities;
(6) Invest 25% or more of its total assets (taken at market value) in
any one industry, provided that this limitation does not apply to
securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, or repurchase agreements thereon; and provided
further that investments by the Western Asset Money Market Portfolio in
U.S. bank instruments (such as bankers' acceptances, certificates of
deposits and time or demand deposits) shall not be considered
investments in any one industry for purposes of this policy; and
provided further that, for purposes of this limitation, U.S. branches
of foreign banks are considered U.S. banks if they are subject to
substantially the same regulation as domestic banks, and foreign
branches of U.S. banks are considered U.S. banks if the domestic parent
would be unconditionally liable in the event that the foreign branch
failed to pay on the instruments for any reason;
(7) Underwrite securities of other issuers, except to the extent that,
in connection with the disposition of portfolio securities, the
Portfolio may be deemed an underwriter under federal securities laws.
Additional Information
With respect to fundamental investment limitations numbered (1) through (4) of
each Portfolio, other than the Western Asset Limited Duration Portfolio and the
Western Asset Core Portfolio, and fundamental investment limitation numbered (9)
of the Western Asset Core Portfolio, the fundamental investment limitations set
forth above limit a Portfolio's ability to engage in certain investment
practices and purchase securities to the extent permitted by, or consistent
with, the 1940 Act. Relevant limitations of the 1940 Act are described below,
which are based either on the 1940 Act itself, the rules or regulations
thereunder, or interpretations promulgated by the SEC. As such, these
limitations of the 1940 Act are not "fundamental," that is, the limitations will
change as the statute, rules, regulations or interpretations change, and no
shareholder vote will be required or sought.
Fundamental investment restriction (1). The 1940 Act presently limits a
Portfolio's ability to borrow up to one-third of the value of its total assets.
Borrowing by a Portfolio allows it to leverage its portfolio, which exposes it
to certain risks. Leveraging increases the effect of any increase or decrease in
the value of portfolio securities on a Portfolio's net asset value, and money
borrowed will be subject to interest costs (which may include commitment fees
and/or the cost of maintaining minimum average balances) which may or may not
exceed the return from the securities purchased with borrowed funds.
The 1940 Act also restricts the ability of any mutual fund to lend. Under the
1940 Act, a Portfolio may only make loans if expressly permitted to do so by the
Portfolio's investment policies, and a Portfolio may not make loans to persons
who control or are under common control with the Portfolio. Thus, the 1940 Act
effectively prohibits a Portfolio from making loans to certain persons when
conflicts of interest or undue influence are most likely present. The Portfolios
may, however, make other loans which if made would expose shareholders to
additional risks, such as the failure of the other party to repay the loan.
-4-
<PAGE>
The ability of a mutual fund to issue senior securities is severely
circumscribed by complex regulatory constraints under the 1940 Act that
restrict, for instance, the amount, timing, and form of senior securities that
may be issued. Certain portfolio management techniques such as the purchase of
securities on margin, short sales, or the writing of puts on portfolio
securities, may be considered senior securities unless appropriate steps are
taken to segregate a Portfolio's assets or otherwise cover its obligations.
Fundamental investment restriction (2). "Concentration" is interpreted under the
1940 Act to mean investment of 25% or more of a Portfolio's total assets in a
single industry. If a Portfolio were to "concentrate" its investments in a
particular industry, investors would be exposed to greater risks because the
Portfolio's performance would be largely dependent on that industry's
performance. None of the Portfolios has reserved the right to concentrate in any
industry. For purposes of this limitation, the Portfolios do not consider
certificates of deposit or banker's acceptances issued by domestic branches of
U.S. or foreign banks to be in a single industry. If, in the future, these
instruments are considered to be in the same industry, the Portfolios reserve
the freedom of action to concentrate in such an industry.
Fundamental investment restriction (3). The 1940 Act prohibits a diversified
mutual fund from underwriting securities in excess of 25% of its total assets.
Fundamental investment restriction (4). This restriction would permit investment
in commodities, commodities contracts (e.g., futures contracts or options),
forward contracts or real estate to the extent permitted under the 1940 Act.
However, it is unlikely that the Portfolios would make such investments, other
than the use of futures contracts, options, forward contracts and certain real
estate-related securities as explained in the Prospectus and this Statement of
Additional Information. Each Portfolio, however, would like the ability to
consider using these investment techniques in the future. Commodities, as
opposed to commodity futures, represent the actual underlying bulk goods, such
as grains, metals and food stuffs. Real estate-related instruments include real
estate investment trusts, commercial and residential mortgage-backed securities,
and real estate financings, and such instruments are generally sensitive to
factors such as changes in real estate values and property taxes, interest
rates, cash flow of underlying real estate assets, overbuilding, and the
management skill and creditworthiness of the issuer.
ADDITIONAL INFORMATION ABOUT SECURITIES,
INVESTMENT TECHNIQUES AND RELATED RISKS
FOREIGN SECURITIES
Investing in the securities of issuers in any foreign country, or in securities
denominated in a foreign currency, involves special risks and considerations not
typically associated with investing in U.S. issuers or U.S. dollar-denominated
securities. These include risks resulting from differences in accounting,
auditing and financial reporting standards; lower liquidity than U.S.
securities; the possibility of nationalization, expropriation or confiscatory
taxation; adverse changes in investment or exchange control regulations (which
may include suspension of the ability to transfer currency out of a country);
and political instability. In many cases, there is less publicly available
information concerning foreign issuers than is available concerning U.S.
issuers. Additionally, purchases and sales of foreign securities and dividends
and interest payable on those securities may be subject to foreign taxes and tax
withholding. Foreign securities generally exhibit greater price volatility and a
greater risk of illiquidity.
To the extent a Portfolio purchases securities denominated in a foreign
currency, a change in the value of any such currency against the U.S. dollar
will result in a change in the U.S. dollar value of the Portfolio's assets and
the Portfolio's income available for distribution. In addition, a Portfolio is
required to compute and distribute its income in U.S. dollars. Therefore, if the
exchange rate for a foreign currency declines after a Portfolio's income has
been earned and translated into U.S. dollars (but before payment), the Portfolio
could be required to liquidate portfolio securities to make such distributions.
Similarly, if an exchange rate declines between the time a Portfolio incurs
expenses in U.S. dollars and the time such expenses are paid, the amount of such
currency required to be converted into U.S. dollars in order to pay such
expenses in U.S. dollars will be greater than the equivalent amount in any such
currency of such expenses at the time they were incurred.
-5-
<PAGE>
The relative performance of various countries' securities markets historically
has reflected wide variations relating to the unique characteristics of each
country's economy. Individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross domestic
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payments position. Bank deposit insurance, if any, may be subject to
widely varying regulations and limits in foreign countries.
Foreign securities purchased by a Portfolio may be listed on foreign exchanges,
traded over-the-counter or purchased in private transactions. Transactions on
foreign exchanges are usually subject to mark-ups or commissions higher than
negotiated commissions on U.S. transactions. There is less government
supervision and regulation of exchanges and brokers in many foreign countries
than in the United States. Additional costs associated with an investment in
foreign securities may include higher custodial fees than apply to domestic
custodial arrangements and transaction costs of foreign currency conversions.
Certain of the foregoing risks may also apply to some extent to securities of
U.S. issuers that are denominated in foreign currencies or that are traded in
foreign markets, or to securities of U.S. issuers having significant foreign
operations.
EMERGING MARKET ISSUERS. The risks of foreign investment, described above, are
greater for investments in emerging market issuers, and such investments should
therefore be considered speculative. Debt securities of governmental and other
issuers in emerging market countries will typically be rated below investment
grade or be of comparable quality. For more information about lower-rated
securities, see "Debt and Fixed Income Securities -- Lower-Rated Securities"
below.
Investors are strongly advised to consider carefully the special risks involved
in emerging markets, which are in addition to the usual risks of investing in
developed markets around the world. Emerging market countries may experience
substantial rates of inflation or deflation. Inflation, deflation and rapid
fluctuations in such rates have had, and may continue to have, very negative
effects on the economies and securities markets of certain emerging market
countries. While some emerging market countries have sought to develop a number
of corrective mechanisms to reduce inflation or deflation or mitigate their
effects, inflation and deflation may continue to have significant effects both
on emerging market countries and their securities markets. In addition, many of
the currencies of emerging market countries have experienced steady devaluations
relative to the U.S. dollar, and major devaluations have occurred in certain
countries.
Economies in emerging market countries generally are dependent heavily upon
international trade and, accordingly, have been and may continue to be affected
adversely by economic conditions, trade barriers, exchange controls, managed
adjustments in relative currency values and other protectionist measures imposed
or negotiated by the countries with which they trade.
Because of the high levels of foreign-denominated debt owed by many emerging
market countries, fluctuating exchange rates can significantly affect the debt
service obligations of those countries. This could, in turn, affect local
interest rates, profit margins and exports, which are a major source of foreign
exchange earnings. Hedging instruments are not typically available with respect
to investments in emerging market countries and, to the extent they are
available, the ongoing and indeterminate nature of the foregoing risks (and the
costs associated with hedging transactions) would make it virtually impossible
to hedge effectively against such risks.
To the extent an emerging market country faces a liquidity crisis with respect
to its foreign exchange reserves, it may increase restrictions on the outflow of
any foreign exchange. Repatriation is ultimately dependent on the ability of a
Portfolio to liquidate its investments and convert the local currency proceeds
obtained from such liquidation into U.S. dollars. Where this conversion must be
done through official channels (usually the central bank or certain authorized
commercial banks), the ability to obtain U.S. dollars is dependent on the supply
of such U.S. dollars through those channels and, if available, upon the
willingness of those channels to allocate those U.S. dollars to the Portfolio.
In such a case, a Portfolio's ability to obtain U.S. dollars may be adversely
affected by any increased restrictions imposed on the outflow of foreign
exchange. If the Portfolio is unable to repatriate any amounts due to exchange
controls, it may be required to accept an obligation payable at some future date
by the central bank or other governmental entity of the jurisdiction involved.
If such conversion can legally be done outside official channels, either
directly or indirectly, a
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Portfolio's ability to obtain U.S. dollars may not be affected as much by any
increased restrictions except to the extent of the price which may be required
to be paid for the U.S. dollars.
Many emerging market countries have little experience with the corporate form of
business organization, and may not have well developed corporation and business
laws or concepts of fiduciary duty in the business context. The securities
markets of emerging market countries are substantially smaller, less developed,
less liquid and more volatile than the securities markets of the U.S. and other
more developed countries. Disclosure and regulatory standards in many respects
are less stringent than in the U.S. and other major markets. There also may be a
lower level of monitoring and regulation of an emerging market country's
securities markets and the activities of investors in such markets; enforcement
of existing regulations has been extremely limited.
Some emerging markets have different settlement and clearance procedures, which,
for example, may not call for delivery of a security to a Portfolio until well
after the Portfolio has paid for such security. In certain markets there have
been times when settlements have been unable to keep pace with the volume of
securities transactions, making it difficult to conduct such transactions. The
inability of a Portfolio to make intended securities purchases due to settlement
problems could cause that Portfolio to miss attractive investment opportunities.
Inability to dispose of a portfolio security caused by settlement problems could
result either in losses to the Portfolio due to subsequent declines in value of
the portfolio security or, if the Portfolio has entered into a contract to sell
the security, in possible liability to the purchaser.
The risk also exists that an emergency situation may arise in one or more
emerging market countries as a result of which trading of securities may cease
or may be substantially curtailed and prices for a Portfolio's portfolio
securities in such markets may not be readily available.
SOVEREIGN DEBT SECURITIES. Sovereign debt is subject to risks in addition to
those relating to foreign investments generally. As a sovereign entity, the
issuing government may be immune from lawsuits in the event of its failure or
refusal to pay the obligations when due. The debtor's willingness or ability to
repay in a timely manner may be affected by, among other factors, its cash flow
situation, the extent of its foreign reserves, the availability of sufficient
foreign exchange on the date a payment is due, the relative size of the debt
service burden to the economy as a whole, the sovereign debtor's policy toward
principal international lenders and the political constraints to which the
sovereign debtor may be subject. Sovereign debtors also may be dependent on
expected disbursements from foreign governments or multinational agencies, the
country's access to trade and other international credits, and the country's
balance of trade. Some emerging market sovereign debtors have in the past
rescheduled their debt payments or declared moratoria on payments, and similar
occurrences may happen in the future.
DEPOSITARY RECEIPTS. American Depositary Receipts, or "ADRs," are securities
issued by a U.S. depositary (usually a bank) and represent a specified quantity
of underlying non-U.S. securities on deposit with a custodian bank as
collateral. A foreign issuer of the security underlying an ADR is generally not
subject to the same reporting requirements in the United States as a domestic
issuer. Accordingly, the information available to a U.S. investor will be
limited to the information the foreign issuer is required to disclose in its own
country and the market value of an ADR may not reflect undisclosed material
information concerning the issuer or the underlying security. ADRs may also be
subject to exchange rate risks if the underlying securities are denominated in
foreign currency. The Portfolios may also invest in similar non-U.S. instruments
issued by foreign banks or trust companies such as "GDRs" and "EDRs." For
purposes of its investment policies, each Portfolio will treat ADRs and similar
instruments as equivalent to investment in the underlying securities.
OPTIONS ON SECURITIES
Under an option contract, one party generally has the right to require the other
to buy or sell a specified amount of securities, units of an index, currencies
or futures contracts, and may exercise that right if the market price of the
underlying instrument moves in a direction advantageous to the holder of the
option. Options with respect to securities indices typically call for cash
settlement instead of delivery of the securities that comprise the index.
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A Portfolio may purchase call options on securities for any purpose. For
example, a call option may be purchased by a Portfolio on a security that its
Adviser intends to include in the Portfolio's investment portfolio in order to
fix the cost of a future purchase. Call options also may be used as a means of
participating in an anticipated price increase of a security on a more limited
risk basis than would be possible if the security itself were purchased. In the
event of a decline in the price of the underlying security, use of this strategy
would serve to limit the Portfolio's potential loss to the option premium paid;
conversely, if the market price of the underlying security increases above the
exercise price and the Portfolio either sells or exercises the option, any
profit realized would be reduced by the premium.
A Portfolio may purchase put options on securities for any purpose. For example,
a put option may be purchased by a Portfolio in order to hedge against a decline
in the market value of securities held in its portfolio. The put option enables
a Portfolio to sell the underlying security at the predetermined exercise price;
thus the potential for loss to the Portfolio below the exercise price is limited
to the option premium paid. If the market price of the underlying security is
higher than the exercise price of the put option, any profit the Portfolio
realizes on the sale of the security would be reduced by the premium paid for
the put option less any amount for which the put option may be sold.
A Portfolio may also write call and put options.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
A futures contract is an agreement between the parties to buy or sell a
specified amount of one or more securities, units of an index or currencies at a
specified price and date; futures contracts are generally closed out by the
parties in advance of that date for a cash settlement.
Each Portfolio will limit its use of futures contracts and futures options to
hedging transactions or other circumstances permitted to registered investment
companies by regulatory authorities. For example, a Portfolio might use futures
contracts to attempt to hedge against anticipated changes in interest rates that
might adversely affect either the value of the Portfolio's securities or the
price of the securities which the Portfolio intends to purchase. A Portfolio's
hedging may include sales of futures contracts as an offset against the effect
of expected increases in interest rates, and purchases of futures contracts as
an offset against the effect of expected declines in interest rates. Although
other techniques could be used to reduce exposure to interest rate fluctuations,
a Portfolio may be able to hedge its exposure more effectively and perhaps at a
lower cost by using futures contracts and options on futures contracts.
Futures contracts may also be used for non-hedging purposes, such as to simulate
full investment in underlying securities while retaining a cash balance for
Portfolio management purposes, as a substitute for direct investment in a
security, to facilitate trading, to reduce transaction costs, or to seek higher
investment returns when a futures contract or option is priced more attractively
than the underlying security or index.
A futures contract on a security or foreign currency is a bilateral agreement
pursuant to which one party agrees to make, and the other party agrees to
accept, delivery of the specified type of security or foreign currency called
for in the contract at a specified future time and at a specified price. A
Portfolio may, for example, purchase a futures contract on a security or foreign
currency when it intends to purchase securities or foreign currency but has not
yet done so. This strategy may minimize the effect of all or part of an increase
in the market price of the security or the relative value of the foreign
currency that a Portfolio intends to purchase in the future. A rise in the price
of the security or foreign currency prior to its purchase may either be offset
by an increase in the value of the futures contract purchased by a Portfolio or
avoided by taking delivery of the security or foreign currency under the futures
contract. Conversely, a fall in the market price of the underlying security or
foreign currency may result in a corresponding decrease in the value of the
futures position. A Portfolio may sell a futures contract on a security or
foreign currency, for example, in order to continue to receive the income from a
security or foreign currency, while endeavoring to avoid part or all of the
decline in the market value of that security that would accompany an increase in
interest rates.
A Portfolio may also purchase a call option on a futures contract to hedge
against a market advance in securities or foreign currency which the Portfolio
plans to acquire at a future date. The purchase of a call option on a futures
contract is analogous to the purchase of a call option on an individual security
or foreign currency which can be used as a
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temporary substitute for a position in the security itself. A Portfolio also may
write covered call options on futures contracts as a partial hedge against a
decline in the price of securities or foreign currency held in the Portfolio's
investment portfolio, or purchase put options on futures contracts in order to
hedge against a decline in the value of securities or foreign currency held in
the Portfolio's investment portfolio. A Portfolio may write a covered put option
as a partial anticipatory hedge.
When a purchase or sale of a futures contract is made by a Portfolio, the
Portfolio is required to deposit with its custodian (or a broker, if legally
permitted) a specified amount of cash or U.S. Government securities ("initial
margin"). The margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term of the
contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Portfolio upon
termination of the contract, assuming all contractual obligations have been
satisfied. Under certain circumstances, such as during periods of high
volatility, a Portfolio may be required by an exchange to increase the level of
its initial margin payment. Additionally, initial margin requirements may be
increased generally in the future by regulatory action. Each Portfolio expects
to earn interest income on its initial margin deposits. A futures contract held
by a Portfolio is valued daily at the official settlement price of the exchange
on which it is traded. Each day the Portfolio pays or receives cash, called
"variation margin," equal to the daily change in value of the futures contract.
This process is known as "marking to market." Variation margin does not
represent a borrowing or loan by a Portfolio but is instead settlement between
the Portfolio and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, each Portfolio
will mark to market its open futures positions.
A Portfolio is also required to deposit and maintain margin with respect to put
and call options on futures contracts written by it. Such margin deposits will
vary depending on the nature of the underlying futures contract (and the related
initial margin requirements) and the current market value of the option and
other futures positions held by the Portfolio.
Although some futures contracts call for making or taking delivery of the
underlying securities or currencies, generally those contracts are closed out
prior to delivery by offsetting purchases or sales of matching futures contracts
(involving the same currency or underlying security and delivery month). If an
offsetting purchase price is less than the original sale price, the Portfolio
realizes a gain, or if it is more, the Portfolio realizes a loss. If an
offsetting sale price is more than the original purchase price, the Portfolio
realizes a gain, or if it is less, the Portfolio realizes a loss. The Portfolio
will also bear transaction costs for each contract which will be included in
these calculations.
A Portfolio will not enter into futures contracts or option positions if,
immediately thereafter, the initial margin deposits plus premiums paid by it,
less the amount by which any such options positions are "in-the-money" at the
time of purchase, would exceed 5% of the fair market value of the Portfolio's
total assets. A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise price. A put
option is "in-the-money" if the exercise price exceeds the value of the futures
contract that is the subject of the option.
The requirements for qualification as a regulated investment company also may
limit the extent to which a Portfolio may enter into futures or options on
futures. See "Additional Tax Information."
RISKS ASSOCIATED WITH FUTURES AND OPTIONS
In considering the Portfolios' use of futures contracts and options, particular
note should be taken of the following:
(1) Positions in futures contracts and options may be closed out only
on an exchange or board of trade which provides a secondary market for
such futures contracts or options. Futures exchanges may limit the
amount of fluctuation permitted in certain futures contract and option
prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract or option may vary
either up or down from the previous day's settlement price at the end
of the current trading session. Once the daily limit has been reached
in a futures contract or option subject to the limit, no more trades
may be made on that day at a price beyond that limit. The daily limit
governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to
prevent
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the liquidation of unfavorable positions. For example, futures prices
have occasionally moved to the daily limit for several consecutive
trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures
contracts to substantial losses.
(2) The ability to establish and close out positions in either futures
contracts or exchange-listed options is also subject to the maintenance
of a liquid secondary market. Consequently, it may not be possible for
a Portfolio to close a position and, in the event of adverse price
movements, the Portfolio would have to make daily cash payments of
variation margin (except in the case of purchased options). However, in
the event futures contracts or options have been used to hedge
portfolio securities, such securities generally will not be sold until
the contracts can be terminated. In such circumstances, an increase in
the price of the securities, if any, may partially or completely offset
losses on the futures contract. However, there is no guarantee that the
price of the securities will, in fact, correlate with the price
movements in the contracts and thus provide an offset to losses on the
contracts. The inability to close out a futures or option position may
also restrict the Portfolio's ability to sell the underlying security
or currency at a time when the Adviser might otherwise do so.
(3) Successful use by a Portfolio of futures contracts and options will
depend upon its Adviser's ability to predict market movements, which
may require different skills and techniques than predicting changes in
the prices of individual securities. Moreover, futures contracts relate
not to the current level of the underlying instrument but to
anticipated levels at some point in the future. There is, in addition,
the risk that movements in the price of the futures contract or option
will not correlate with movements in the prices of the securities or
currencies being hedged. If the price of the securities or currencies
being hedged has moved in a favorable direction, this advantage may be
partially offset by losses in the futures or option position. In
addition, if the Portfolio has insufficient cash, it may have to sell
assets from its investment portfolio to meet daily variation margin
requirements. Any such sale of assets may or may not be made at prices
that reflect the rising market; consequently, a Portfolio may need to
sell assets at a time when such sales are disadvantageous to the
Portfolio. If the price of the futures or option contract moves more
than the price of the underlying securities or currencies, the
Portfolio will experience either a loss or a gain on the futures
contract or option that may or may not be completely offset by
movements in the price of the securities or currencies that are the
subject of the hedge.
(4) The value of an option position will reflect, among other things,
the current market price of the underlying security, currency or
futures contract, the time remaining until expiration, the relationship
of the exercise price to the market price, the historical price
volatility of the underlying security, currency or futures contract and
general market conditions. For this reason, the successful use of
options as a hedging strategy depends upon the Adviser's ability to
forecast the direction of price fluctuations in the underlying market.
(5) In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between price movements in the
futures and options position and the securities or currencies being
hedged, movements in the prices of futures and options contracts may
not correlate perfectly with movements in the prices of the hedged
securities or currencies due to price distortions in the futures and
options markets. There may be several reasons unrelated to the value of
the underlying securities or currencies which cause this situation to
occur. First, as noted above, all participants in the futures market
are subject to initial and variation margin requirements. If, to avoid
meeting additional margin deposit requirements or for other reasons,
investors choose to close a significant number of futures contracts
through offsetting transactions, distortions in the normal price
relationship between the securities or currencies and the futures
markets may occur. Second, because the margin deposit requirements in
the futures market are less onerous than margin requirements in the
securities market, there may be increased participation by speculators
in the futures market; such speculative activity in the futures market
also may cause temporary price distortions. Third, participants could
make or take delivery of the underlying securities or currencies
instead of closing out their contracts. As a result, a correct forecast
of general market trends may not result in successful hedging through
the use of futures or options contracts over the short term. In
addition, activities of large traders involving arbitrage and other
investment strategies may result in temporary price distortions.
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(6) Options normally have expiration dates of up to nine months. The
exercise price of the options may be below, equal to or above the
current market value of the underlying security, currency or futures
contract. Options that expire unexercised have no value, and the
Portfolio will realize a loss in the amount paid and any transaction
costs.
(7) Like options on securities, options on futures contracts have a
limited life. The ability to establish and close out options on futures
will be subject to the development and maintenance of liquid secondary
markets on the relevant exchanges or boards of trade. There can be no
certainty that liquid secondary markets for all options on futures
contracts will develop.
(8) Purchasers of options on futures contracts pay a premium in cash at
the time of purchase. This amount and the transaction costs are all
that is at risk. Sellers of options on futures contracts, however, must
post an initial margin and are subject to additional margin calls which
could be substantial in the event of adverse price movements. In
addition, although the maximum amount at risk when the Portfolio
purchases an option is the premium paid for the option and the
transaction costs, there may be circumstances when the purchase of an
option on a futures contract would result in a loss to the Portfolio
when the use of a futures contract would not, such as when there is no
movement in the value of the securities or currencies being hedged.
(9) A Portfolio's activities in the futures and options markets may
result in a higher portfolio turnover rate and additional transaction
costs in the form of added brokerage commissions; however, a Portfolio
also may save on commissions by using such contracts as a hedge rather
than buying or selling individual securities in anticipation or as a
result of market movements.
(10) A Portfolio may purchase and write both exchange-traded options
and options traded on the OTC market. Exchange markets for options on
debt securities exist but are relatively new, and the ability to
establish and close out positions on the exchanges is subject to the
maintenance of a liquid secondary market. Although the Portfolios
intend to purchase or write only those exchange-traded options for
which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular
option at any specific time. Closing transactions may be effected with
respect to options traded in the OTC markets only by negotiating
directly with the other party to the option contract, or in a secondary
market for the option if such market exists. Although the Portfolios
will enter into OTC options only with dealers which agree to enter
into, and which are expected to be capable of entering into, closing
transactions with the Portfolios, there can be no assurance that a
Portfolio will be able to liquidate an OTC option at a favorable price
at any time prior to expiration. In the event of insolvency of the
contra-party, a Portfolio may be unable to liquidate an OTC option.
Accordingly, it may not be possible to effect closing transactions with
respect to certain options, with the result that the Portfolio would
have to exercise those options which it has purchased in order to
realize any profit. With respect to options written by a Portfolio, the
inability to enter into a closing transaction may result in material
losses to the Portfolio. For example, because a Portfolio must maintain
a covered position with respect to any call option it writes on a
security or futures contract the Portfolio may not sell the underlying
security or futures contract or invest any cash, U.S. Government
securities or short-term debt securities used as cover during the
period it is obligated under such option. This requirement may impair a
Portfolio's ability to sell a portfolio security or make an investment
at a time when such a sale or investment might be advantageous.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS AND OPTIONS ON
FUTURES CONTRACTS TRADED ON FOREIGN EXCHANGES
Options on securities, options on currencies, futures contracts and options on
futures contracts may be traded on foreign exchanges. Such transactions may not
be regulated as effectively as similar transactions in the United States, may
not involve a clearing mechanism and related guarantees and are subject to the
risk of governmental actions affecting trading in, or the price of, foreign
securities. The value of such positions also could be adversely affected by (1)
other complex foreign political, legal and economic factors, (2) lesser
availability than in the United States of data on which to make trading
decisions, (3) delays in the Portfolios' ability to act upon economic events
occurring in foreign markets
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during non-business hours in the United States, (4) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States and (5) lesser trading volume.
COVER FOR HEDGING STRATEGIES
Each Portfolio will comply with guidelines established by the SEC with respect
to coverage of hedging strategies by mutual funds, and, if the guidelines so
require, will set aside cash or liquid securities in a segregated account with
its custodian in the amount prescribed, as marked to market daily. Securities,
options or futures positions used for cover and securities held in a segregated
account cannot be sold or closed out while the hedging strategy is outstanding,
unless they are replaced with similar assets. As a result, there is a
possibility that the use of cover or segregation involving a large percentage of
a Portfolio's assets could impede portfolio management or a Portfolio's ability
to meet redemption requests or other current obligations.
FOREIGN CURRENCY EXCHANGE TRANSACTIONS
Each Portfolio that may invest in securities that are denominated in foreign
currencies may engage in a variety of foreign currency exchange transactions to
protect against uncertainty in the level of future exchange rates. These
transactions may be engaged in connection with the purchase and sale of
portfolio securities ("transaction hedging") and to protect the value of
specific portfolio positions ("position hedging").
A Portfolio may engage in transaction hedging to protect against a change in the
foreign currency exchange rates between the date on which the Portfolio
contracts to purchase or sell the security and the settlement date, or to "lock
in" the U.S. dollar equivalent of a dividend or interest payment in a foreign
currency. A Portfolio may purchase or sell a foreign currency on a spot (or
cash) basis at the prevailing spot rate. If conditions warrant, for transaction
hedging purposes, a Portfolio may also enter into contracts to purchase or sell
foreign currencies at a future date ("forward contracts") and may purchase and
sell foreign currency futures contracts. A foreign currency forward contract is
a negotiated agreement to exchange currency at a future time at a rate or rates
that may be higher or lower than the spot rate. Foreign currency futures
contracts are standardized exchange-traded contracts and have margin
requirements. Each Portfolio may also purchase, sell and write exchange-listed
and over-the-counter call and put options on foreign currency futures contracts
and on foreign currencies.
A Portfolio may engage in "position hedging" to protect against a decline in the
value relative to the U.S. dollar of the currencies in which its portfolio
securities are denominated or quoted (or an increase in the value of the
currency in which securities the Portfolio intends to buy are denominated).
For position hedging purposes, each Portfolio may purchase, sell or write
foreign currency futures contracts, foreign currency forward contracts, and
options on exchanges or over-the-counter markets. In connection with position
hedging, a Portfolio may also purchase or sell foreign currency on a spot basis.
A Portfolio's currency hedging transactions may call for the delivery of one
foreign currency in exchange for another foreign currency and may at times
involve currencies other than those in which its portfolio securities are then
denominated. "Cross hedging" activities will be used when a Portfolio's Adviser
believes that such transactions provide significant hedging opportunities for
the Portfolio. Cross hedging transactions by a Portfolio involve the further
risk of imperfect correlation between changes in the values of the currencies to
which such transactions relate and changes in the values of such currencies and
of the currency or other asset or liability which is the subject of the hedge.
The decision as to whether and to what extent a Portfolio will engage in foreign
currency exchange transactions will depend on a number of factors, including
prevailing market conditions, the composition of a Portfolio's investments and
the availability of suitable transactions. Accordingly, there can be no
assurance that a Portfolio will engage in foreign currency exchange transactions
at any given time or from time to time.
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For a further discussion of the risks associated with purchasing and selling
futures contracts and options, see "Options and Futures" above. A Portfolio may
also use other foreign currency exchange instruments and techniques when
available and deemed appropriate by its Adviser.
PREFERRED STOCKS AND CONVERTIBLE SECURITIES
A preferred stock pays dividends at a specified rate and has preference over
common stock in the payment of dividends and the liquidation of an issuer's
assets but is junior to the debt securities of the issuer in those same
respects. The market prices of preferred stocks are subject to changes in
interest rates and are more sensitive to changes in an issuer's creditworthiness
than are the prices of debt securities. Shareholders of preferred stock may
suffer a loss of value if dividends are not paid. Under ordinary circumstances,
preferred stock does not carry voting rights.
A convertible security is a bond, debenture, note, preferred stock or other
security that may be converted into or exchanged for a prescribed amount of
common stock (or another equity security) of the same or a different issuer
within a particular period of time at a specified price or formula. A
convertible security entitles the holder to receive interest paid or accrued on
debt or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion, convertible
securities have characteristics similar to nonconvertible debt securities in
that they ordinarily provide a stream of income with generally higher yields
than those of common stocks of the same or similar issuers. Convertible
securities are usually subordinated to comparable-tier nonconvertible securities
but rank senior to common stock in a corporation's capital structure.
The value of a convertible security is a function of (1) its yield in comparison
with the yields of other securities of comparable maturity and quality that do
not have a conversion privilege and (2) its worth, at market value, if converted
into the underlying common stock. A convertible security may be subject to
redemption at the option of the issuer at a price established in the convertible
security's governing instrument. If a convertible security held by a Portfolio
is called for redemption, the Portfolio will be required to (1) permit the
issuer to redeem the security, (2) convert it into the underlying common stock
or (3) sell it to a third party. Any of these actions could have an adverse
effect on a Portfolio's ability to achieve its investment objective.
DEBT AND FIXED INCOME SECURITIES
The Portfolios may invest in a variety of debt and fixed income securities.
These securities share one principal risk: their values fluctuate with changes
in interest rates. Thus, a decrease in interest rates will generally result in
an increase in the value of a Portfolio's fixed income investments. Conversely,
during periods of rising interest rates, the value of a Portfolio's fixed income
investments will generally decline. The magnitude of these fluctuations will
generally be greater when a Portfolio's duration or average maturity is longer.
Changes in the value of portfolio securities will not affect interest income
from those securities, but will be reflected in a Portfolio's net asset value.
The most common types of these instruments, and the associated risks, are
described below. Subject to its investment policies and applicable law, each of
the Portfolios may invest in these and other instruments.
U.S. GOVERNMENT OBLIGATIONS. U.S. Government securities include (1) U.S.
Treasury bills (maturity of one year or less), U.S. Treasury notes (maturity of
one to ten years) and U.S. Treasury bonds (maturities generally greater than ten
years) and (2) obligations issued or guaranteed by U.S. Government agencies or
instrumentalities which are supported by any of the following: (a) the full
faith and credit of the U.S. Government (such as GNMA certificates); (b) the
right of the issuer to borrow an amount limited to a specific line of credit
from the U.S. Government (such as obligations of the Federal Home Loan Banks);
(c) the discretionary authority of the U.S. Government to purchase certain
obligations of agencies or instrumentalities (such as securities issued by
Fannie Mae); or (d) only the credit of the instrumentality (such as securities
issued by Freddie Mac). In the case of obligations not backed by the full faith
and credit of the United States, a Portfolio must look principally to the agency
or instrumentality issuing or guaranteeing the obligation for ultimate repayment
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitments. Neither the
U.S. Government nor any of its agencies or instrumentalities guarantees the
market value of the securities they issue. Therefore, the market value of such
securities will fluctuate in response to changes in interest rates.
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INFLATION-INDEXED SECURITIES. The Portfolios may also invest in
inflation-indexed U.S. Treasury securities (also known as "Treasury
Inflation-Protection Securities"). The principal value of Treasury
Inflation-Protection Securities is adjusted daily in accordance with changes in
the Consumer Price Index, while interest is calculated on the basis of the
adjusted principal value on the payment date. The principal value of these
securities declines in periods of deflation, but holders at maturity receive no
less than par. If inflation is lower than expected during the period a Portfolio
holds the security, the Portfolio may earn less on the security than on a
conventional bond. Any increase in principal value is taxable in the year the
increase occurs, even though holders do not receive cash representing the
increase at that time. Changes in market interest rates from causes other than
inflation will likely affect the price of these securities in the same manner as
more traditional obligations.
MORTGAGE-RELATED SECURITIES. Mortgage-related securities represent an interest
in a pool of mortgages made by lenders such as commercial banks, savings and
loan institutions, mortgage bankers and others. Mortgage-related securities may
be issued by governmental, government-related or non-governmental entities, and
provide regular payments which consist of interest and, in most cases,
principal. In contrast, other forms of debt securities normally provide for
periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. In effect, payments on mortgage-related
securities are a "pass-through" of the payments made by the individual borrowers
on their mortgage loans, net of any fees paid to the issuer or guarantor of such
securities. Additional payments to holders of mortgage-related securities are
caused by repayments resulting from the sale of the underlying property,
refinancing or foreclosure, net of fees or costs which may be incurred.
As prepayment rates of individual pools of mortgage loans vary widely, it is not
possible to predict accurately the average life of a particular security.
Although mortgage-related securities are issued with stated maturities of up to
forty years, unscheduled or early payments of principal and interest on the
underlying mortgages may shorten considerably the securities' effective
maturities. The volume of prepayments of principal on a pool of mortgages
underlying a particular mortgage-related security will influence the yield of
that security, and the principal returned to a Portfolio may be reinvested in
instruments whose yield may be higher or lower than that which might have been
obtained had such prepayments not occurred. When interest rates are declining,
such prepayments usually increase, and reinvestments of such principal
prepayments will be at a lower rate than that on the original mortgage-related
security. An increase in mortgage prepayments could cause the Portfolio to incur
a loss on a mortgage-related security that was purchased at a premium. On the
other hand, a decrease in the rate of prepayments, resulting from an increase in
market interest rates or other causes, may extend the effective maturities of
mortgage-related securities, increasing their sensitivity to changes in market
interest rates and potentially increasing the volatility of a Portfolio's
shares. The rate of prepayment may also be affected by general economic
conditions, the location and age of the mortgages, and other social and
demographic conditions. In determining the average maturity or duration of a
mortgage-related security, a Portfolio's Adviser must apply certain assumptions
and projections about the maturity and prepayment of such security; actual
prepayment rates may differ. Because of prepayments, mortgage-related securities
may have less potential for capital appreciation during periods of declining
interest rates than other securities of comparable maturities, although they may
have a similar risk of decline in market value during periods of rising interest
rates.
Most issuers or poolers provide guarantees of payments, regardless of whether
the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are often backed by various forms of credit, insurance and collateral,
although these may be in amounts less than the full obligation of the pool to
its shareholders.
Pools often consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of one- to four-family homes. The
terms and characteristics of the mortgage instruments are generally uniform
within a pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, the Portfolios may purchase pools of variable-rate
mortgages, growing-equity mortgages, graduated-payment mortgages and other
types.
All poolers apply standards for qualification to lending institutions which
originate mortgages for the pools. Poolers also establish credit standards and
underwriting criteria for individual mortgages included in the pools. In
addition, many mortgages included in pools are insured through private mortgage
insurance companies.
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The average life of mortgage-related securities varies with the maturities and
the nature of the underlying mortgage instruments. For example, securities
issued by the Government National Mortgage Association ("GNMA") tend to have a
longer average life than participation certificates ("PCs") issued by the
Federal Home Loan Mortgage Corporation ("FHLMC") because there is a tendency for
the conventional and privately-insured mortgages underlying FHLMC PCs to repay
at faster rates than the Federal Housing Administration and Veterans
Administration loans underlying GNMAs. In addition, the term of a security may
be shortened by unscheduled or early payments of principal and interest on the
underlying mortgages. The occurrence of mortgage prepayments is affected by
factors including the level of interest rates, general economic conditions, the
location and age of the mortgage and other social and demographic conditions.
In determining the dollar-weighted average maturity of a Portfolio, the
Portfolio's Adviser will follow industry practice in assigning an average life
to the mortgage-related securities held by each Portfolio unless the interest
rate on the mortgages underlying the securities is such that a different
prepayment rate is likely. For example, if a GNMA has a high interest rate
relative to the market, that GNMA is likely to have a shorter overall maturity
than a GNMA with a market rate coupon. Moreover, Western Asset may deem it
appropriate to change the projected average life for a Portfolio's
mortgage-related securities as a result of fluctuations in market interest rates
and other factors.
Yields on mortgage-related securities are typically quoted based on the maturity
of the underlying instruments and the associated average life assumption. Actual
prepayment experience may cause the yield to differ from the yield expected on
the basis of average life. Reinvestment of the prepayments may occur at higher
or lower interest rates than the original investment, thus affecting the yield
of the Portfolio. The compounding effect from reinvestments of monthly payments
received by each Portfolio will increase the yield to shareholders compared to
bonds that pay interest semi-annually.
GOVERNMENT MORTGAGE-RELATED SECURITIES. GNMA is the principal federal government
guarantor of mortgage-related securities. GNMA is a wholly owned U.S. Government
corporation within the Department of Housing and Urban Development. GNMA
pass-through securities are considered to have a relatively low risk of default
in that (1) the underlying mortgage loan portfolio is comprised entirely of
government-backed loans and (2) the timely payment of both principal and
interest on the securities is guaranteed by the full faith and credit of the
U.S. Government, regardless of whether they have been collected. GNMA
pass-through securities are, however, subject to the same market risk as
comparable debt securities. Therefore, the effective maturity and market value
of a Portfolio's GNMA securities can be expected to fluctuate in response to
changes in interest rate levels.
Residential mortgage loans are also pooled by Freddie Mac, a corporate
instrumentality of the U.S. Government. The mortgage loans in Freddie Mac's
portfolio are not government backed; Freddie Mac, not the U.S. Government,
guarantees the timely payment of interest and ultimate collection of principal
on Freddie Mac securities. Freddie Mac also issues guaranteed mortgage
certificates, on which it guarantees semiannual interest payments and a
specified minimum annual payment of principal.
Fannie Mae is a government-sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of Housing
and Urban Development. Fannie Mae purchases residential mortgages from a list of
approved seller/servicers, which include savings and loan associations, savings
banks, commercial banks, credit unions and mortgage bankers. Pass-through
securities issued by Fannie Mae are guaranteed as to timely payment of principal
and interest only by Fannie Mae, not the U.S. Government.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. Mortgage-related securities
offered by private issuers include pass-through securities comprised of pools of
residential mortgage loans; mortgage-backed bonds which are considered to be
debt obligations of the institution issuing the bonds and are collateralized by
mortgage loans; and bonds and collateralized mortgage obligations ("CMOs") which
are collateralized by mortgage-related securities issued by Freddie Mac, Fannie
Mae or GNMA or by pools of mortgages.
CMOs are typically structured with classes or series which have different
maturities and are generally retired in sequence. Each class of obligations
receives periodic interest payments according to the coupon rate on the
obligations. However, all monthly principal payments and any prepayments from
the collateral pool are generally paid first to the
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"Class 1" holders. Thereafter, all payments of principal are generally allocated
to the next most senior class of obligations until that class of obligations has
been fully repaid. Although full payoff of each class of obligations is
contractually required by a certain date, any or all classes of obligations may
be paid off sooner than expected because of an increase in the payoff speed of
the pool. Other allocation methods may be used. Payment of interest or principal
on some classes or series of a CMO may be subject to contingencies or some
classes or series may bear some or all of the risk of default on the underlying
mortgages.
Mortgage-related securities created by non-governmental issuers generally offer
a higher rate of interest than government and government-related securities
because there are no direct or indirect government guarantees of payment in the
former securities, resulting in higher risks. Where privately issued securities
are collateralized by securities issued by Freddie Mac, Fannie Mae or GNMA, the
timely payment of interest and principal is supported by the government-related
securities collateralizing such obligations. The market for conventional pools
is smaller and less liquid than the market for the government and
government-related mortgage pools.
Certain private mortgage pools are organized in such a way that the SEC staff
considers them to be closed-end investment companies. Each Portfolio's
investment in such pools is constrained by federal statute, which restricts
investments in the shares of other investment companies.
The private mortgage-related securities in which the Portfolios may invest
include foreign mortgage pass-through securities ("Foreign Pass-Throughs"),
which are structurally similar to the pass-through instruments described above.
Such securities are issued by originators of and investors in mortgage loans,
including savings and loan associations, mortgage bankers, commercial banks,
investment bankers, specialized financial institutions and special purpose
subsidiaries of the foregoing. Foreign Pass-Throughs usually are backed by a
pool of fixed rate or adjustable-rate mortgage loans. Certain Foreign
Pass-Throughs in which the Portfolios invest typically are not guaranteed by an
entity having the credit status of GNMA, but generally utilize various types of
credit enhancement.
ASSET-BACKED SECURITIES. Asset-backed securities refer to securities that
directly or indirectly represent a participation in, or are secured by and
payable from, assets such as motor vehicle installment sales, installment loan
contracts, leases of various types of real and personal property and receivables
from revolving credit (credit card) agreements.
Such assets are securitized through the use of trusts or special purpose
corporations. Asset-backed securities are backed by a pool of assets
representing the obligations often of a number of different parties. Certain of
such securities may be illiquid.
The principal on asset-backed securities, like that on mortgage-backed
securities, may be prepaid at any time. As a result, if such securities are
purchased at a premium, a prepayment rate that is faster than expected will
reduce yield to maturity, while a prepayment rate that is slower than expected
will have the opposite effect. Conversely, if the securities are purchased at a
discount, prepayments faster than expected will increase yield to maturity and
prepayments slower than expected will decrease it. Accelerated prepayments also
reduce the certainty of the yield because the Portfolio must reinvest the assets
at the then-current rates. Accelerated prepayments on securities purchased at a
premium also impose a risk of loss of principal. On the other hand, a decrease
in the rate of prepayments may extend the effective maturities of the
securities, increasing their sensitivity to changes in market interest rates and
potentially increasing the volatility of a Portfolio's shares. The rate of
prepayment may also be affected by general economic conditions and other social
and demographic conditions.
Each type of asset-backed security also entails unique risks depending on the
type of assets involved and the legal structure used. For example, credit card
receivables are generally unsecured obligations of the credit card holder and
the debtors are entitled to the protection of a number of state and federal
consumer credit laws, many of which give such debtors the right to set off
certain amounts owed on the credit cards, thereby reducing the balance due.
There have also been proposals to cap the interest rate that a credit card
issuer may charge. In some transactions, the value of the asset-backed security
is dependent on the performance of a third party acting as credit enhancer or
servicer. Furthermore, in some transactions (such as those involving the
securitization of vehicle loans or leases) it may be administratively
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burdensome to perfect the interest in the underlying collateral, and the
underlying collateral may become damaged or stolen.
Most issuers of automobile receivables permit the servicers to retain possession
of the underlying obligations. If the servicer were to sell these obligations to
another party, there is a risk that the purchaser would acquire an interest
superior to that of the holders of the related automobile receivables. In
addition, because of the large number of vehicles involved in a typical issuance
and technical requirements under state laws, the trustee for the holders of the
automobile receivables may not have a proper security interest in all of the
obligations backing such receivables. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be available to
support payments on these securities. Because asset-backed securities are
relatively new, the market experience in these securities is limited and the
market's ability to sustain liquidity through all phases of the market cycle is
not certain.
MUNICIPAL OBLIGATIONS. Municipal obligations include obligations issued to
obtain funds for various public purposes, including constructing a wide range of
public facilities, such as bridges, highways, housing, hospitals, mass
transportation, schools and streets. Other public purposes for which municipal
obligations may be issued include the refunding of outstanding obligations, the
obtaining of funds for general operating expenses and the making of loans to
other public institutions and facilities. In addition, certain types of
industrial development bonds ("IDBs") and private activity bonds ("PABs") are
issued by or on behalf of public authorities to finance various privately
operated facilities, including certain pollution control facilities, convention
or trade show facilities, and airport, mass transit, port or parking facilities.
Municipal obligations also include short-term tax anticipation notes, bond
anticipation notes, revenue anticipation notes and other forms of short-term
debt obligations. Such notes may be issued with a short-term maturity in
anticipation of the receipt of tax payments, the proceeds of bond placements or
other revenues. Municipal obligations also include municipal lease obligations
and certificates of participation. Municipal lease obligations, which are issued
by state and local governments to acquire land, equipment and facilities,
typically are not fully backed by the municipality's credit, and, if funds are
not appropriated for the following year's lease payments, a lease may terminate,
with the possibility of default on the lease obligation and significant loss to
the Portfolio. Certificates of participation are participations in municipal
lease obligations or installment sales contracts. Each certificate represents a
proportionate interest in or right to the payments made.
The two principal classifications of municipal obligations are "general
obligation" and "revenue" bonds. "General obligation" bonds are secured by the
issuer's pledge of its faith, credit and taxing power. "Revenue" bonds are
payable only from the revenues derived from a particular facility or class of
facilities or from the proceeds of a special excise tax or other specific
revenue source such as the corporate user of the facility being financed. IDBs
and PABs are usually revenue bonds and are not payable from the unrestricted
revenues of the issuer. The credit quality of IDBs and PABs is usually directly
related to the credit standing of the corporate user of the facilities.
The ability of state, county or local governments to meet their obligations will
depend primarily on the availability of tax and other revenues to those
governments and on their fiscal conditions generally. The amounts of tax and
other revenues available to governmental issuers may be affected from time to
time by economic, political and demographic conditions within or outside of the
particular state. In addition, constitutional or statutory restrictions may
limit a government's power to raise revenues or increase taxes. The availability
of federal, state and local aid to issuers of municipal securities may also
affect their ability to meet their obligations. Payments of principal and
interest on revenue bonds will depend on the economic condition of the facility
or specific revenue source from whose revenues the payments will be made. The
facility's economic status, in turn, could be affected by economic, political
and demographic conditions affecting the particular state.
CORPORATE DEBT SECURITIES. A Portfolio may invest in debt securities (i.e.,
bonds, debentures, notes and other similar debt instruments) of domestic or
foreign non-governmental issuers which meet the minimum credit quality criteria,
if any, set forth for the Portfolio. Corporate debt securities may pay fixed or
variable rates of interest, or interest at a rate contingent upon some other
factor, such as the price of some commodity. These securities may include
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warrants, may be convertible into preferred or common equity, or may be bought
as part of a unit containing common stock.
LOWER-RATED SECURITIES. Non-investment grade securities, i.e., securities rated
below Baa by Moody's or BBB by S&P or comparable ratings of other NRSROs or
unrated securities of comparable quality, are described as "speculative" by
Moody's and S&P and may be subject to greater market fluctuations and greater
risk of loss of income or principal, including a greater possibility of default
or bankruptcy of the issuer of such securities, than are more highly rated debt
securities. Such securities are commonly referred to as "junk bonds." A
Portfolio's Adviser seeks to minimize the risks of investing in all securities
through diversification, in-depth credit analysis and attention to current
developments in interest rates and market conditions and will monitor the
ratings of securities held by the Portfolios and the creditworthiness of their
issuers. If the rating of a security in which a Portfolio has invested falls
below the minimum rating in which the Portfolio is permitted to invest, the
Portfolio will either dispose of that security within a reasonable time or hold
the security for so long as the Portfolio's Adviser determines appropriate for
that Portfolio, having due regard for market conditions, tax implications and
other applicable factors. See the Appendix to the Prospectus for a description
of the ratings assigned to fixed income securities by the rating agencies.
A debt security may be callable, i.e., subject to redemption at the option of
the issuer at a price established in the security's governing instrument. If a
debt security held by a Portfolio is called for redemption, the Portfolio will
be required to permit the issuer to redeem the security or sell it to a third
party. Either of these actions could have an adverse effect on a Portfolio's
ability to achieve its investment objective because, for example, the Portfolio
may be able to reinvest the proceeds only in securities with lower yields or may
receive a price upon sale that is lower than it would have received in the
absence of the redemption.
The market for lower-rated securities has expanded rapidly in recent years. This
growth has paralleled a long economic expansion. At certain times in the past,
the prices of many lower-rated securities declined, indicating concerns that
issuers of such securities might experience financial difficulties. At those
times, the yields on lower-rated securities rose dramatically, reflecting the
risk that holders of such securities could lose a substantial portion of their
value as a result of the issuers' financial restructuring or default. There can
be no assurance that such declines will not recur.
The ratings of Moody's and S&P represent the opinions of those agencies as to
the quality of the debt securities which they rate. Such ratings are relative
and subjective, and are not absolute standards of quality. Unrated debt
securities are not necessarily of lower quality than rated securities, but they
may not be attractive to as many buyers. If securities are rated investment
grade by one rating organization and below investment grade by the other, a
Portfolio's investment adviser may rely on the rating that it believes is more
accurate. Each Portfolio's Adviser will consider a security's quality and credit
rating when determining whether such security is an appropriate investment.
Subject to its investment objective, policies and applicable law, a Portfolio
may purchase a security with the lowest rating.
Where one of the NRSROs has assigned an investment grade rating to an instrument
and others have given it a lower rating, the Portfolios may consider the
instrument to be investment grade. The market for lower-rated securities may be
thinner and less active than that for higher-rated securities, which can
adversely affect the prices at which these securities can be sold, and may make
it difficult for a Portfolio to obtain market quotations daily. If market
quotations are not available, these securities will be valued by a method that
the Portfolios' Boards of Directors believe accurately reflects fair market
value. Judgment may play a greater role in valuing lower-rated debt securities
than is the case with respect to securities for which a broader range of dealer
quotations and last-sale information is available. Adverse publicity and
investor perceptions, whether or not based on fundamental analysis, may also
decrease the values and liquidity of lower-rated securities, especially in a
thinly traded market.
Although the prices of lower-rated bonds are generally less sensitive to
interest rate changes than are higher-rated bonds, the prices of lower-rated
bonds may be more sensitive to adverse economic changes and developments
regarding the individual issuer. Although the market for lower-rated debt
securities is not new, and the market has previously weathered economic
downturns, there has been in recent years a substantial increase in the use of
such securities to fund corporate acquisitions and restructurings. Accordingly,
the past performance of the market for such securities may not be an accurate
indication of its performance during future economic downturns or periods of
rising interest rates. When
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economic conditions appear to be deteriorating, medium- to lower-rated
securities may decline in value due to heightened concern over credit quality,
regardless of the prevailing interest rates. Investors should carefully consider
the relative risks of investing in high yield securities and understand that
such securities are not generally meant for short-term investing.
Adverse economic developments can disrupt the market for lower-rated securities,
and severely affect the ability of issuers, especially highly leveraged issuers,
to service their debt obligations or to repay their obligations upon maturity
which may lead to a higher incidence of default on such securities. Lower-rated
securities are especially affected by adverse changes in the industries in which
the issuers are engaged and by changes in the financial condition of the
issuers. Highly leveraged issuers may also experience financial stress during
periods of rising interest rates. In addition, the secondary market for
lower-rated securities, which is concentrated in relatively few market makers,
may not be as liquid as the secondary market for more highly rated securities.
As a result, a Portfolio could find it more difficult to sell these securities
or may be able to sell the securities only at prices lower than if such
securities were widely traded. Therefore, prices realized upon the sale of such
lower rated or unrated securities, under these circumstances, may be less than
the prices used in calculating a Portfolio's net asset value.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls an obligation for redemption, the Portfolio may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If a Portfolio experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Portfolio's investment portfolio
and increasing the exposure of the Portfolio to the risks of lower-rated
securities.
STRIPPED SECURITIES. Stripped securities are created by separating bonds into
their principal and interest components and selling each piece separately
(commonly referred to as IOs and POs). The yield to maturity on an IO or PO
class of stripped mortgage-backed securities is extremely sensitive not only to
changes in prevailing interest rates but also to the rate of principal payments
(including prepayments) on the underlying assets. A rapid rate of principal
prepayments may have a measurably adverse effect on a Portfolio's yield to
maturity to the extent it invests in IOs. If the assets underlying the IOs
experience greater than anticipated prepayments of principal, the Portfolio may
fail to recoup fully its initial investment in these securities. Conversely, POs
tend to increase in value if prepayments are greater than anticipated and
decline if prepayments are slower than anticipated. The secondary market for
stripped mortgage-backed securities may be more volatile and less liquid than
that for other mortgage-backed securities, potentially limiting a Portfolio's
ability to buy or sell those securities at any particular time.
ZERO COUPON AND PAY-IN-KIND SECURITIES. A zero coupon bond is a security that
makes no fixed interest payments but instead is sold at a discount from its face
value. The bond is redeemed at its face value on the specified maturity date.
Zero coupon bonds may be issued as such, or they may be created by a broker who
strips the coupons from a bond and separately sells the rights to receive
principal and interest. The prices of zero coupon bonds tend to fluctuate more
in response to changes in market interest rates than do the prices of
interest-paying debt securities with similar maturities. A Portfolio investing
in zero coupon bonds generally accrues income on such securities prior to the
receipt of cash payments. Since each Portfolio must distribute substantially all
of its income to shareholders to qualify as a regulated investment company under
federal income tax law, a Portfolio investing in zero coupon bonds may have to
dispose of other securities to generate the cash necessary for the distribution
of income attributable to its zero coupon bonds. Pay-in-kind securities have
characteristics similar to those of zero coupon securities, but interest on such
securities may be paid in the form of obligations of the same type rather than
cash.
COMMERCIAL PAPER AND OTHER SHORT-TERM INVESTMENTS
Each of the Portfolios may invest or hold cash or other short-term investments,
including commercial paper. Commercial paper represents short-term unsecured
promissory notes issued in bearer form by banks or bank holding companies,
corporations and finance companies. The Portfolios may purchase commercial paper
issued pursuant to the private placement exemption in Section 4(2) of the
Securities Act of 1933. Section 4(2) paper is restricted as to disposition under
federal securities laws in that any resale must similarly be made in an exempt
transaction. The Portfolios may or may not regard such securities as illiquid,
depending on the circumstances of each case.
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Any Portfolio may also invest in obligations (including certificates of deposit,
demand and time deposits and bankers' acceptances) of U.S. banks and savings and
loan institutions. While domestic bank deposits are insured by an agency of the
U.S. Government, the Portfolios will generally assume positions considerably in
excess of the insurance limits.
LOAN PARTICIPATIONS AND ASSIGNMENTS
The purchase of loan participations and assignments entails special risks. A
Portfolio's ability to receive payments of principal and interest and other
amounts in connection with loan participations and assignments will depend
primarily on the financial condition of the borrower. The failure by the
Portfolio to receive scheduled interest or principal payments on a loan
participation or assignment would adversely affect the income of the Portfolio
and would likely reduce the value of its assets. Because loan participations are
not generally rated by independent credit rating agencies, a decision by a
Portfolio to invest in a particular loan participation will depend almost
exclusively on its Adviser's credit analysis of the borrower. In addition to the
other risks associated with investments in debt securities, participations and
assignments involve the additional risk that the insolvency of any financial
institution interposed between the Portfolio and the borrower could delay or
prevent the flow of payments from the borrower on the underlying loan. A
Portfolio may have limited rights to enforce the terms of the underlying loan,
and the liquidity of loan participations and assignments may be limited.
The borrower of a loan in which a Portfolio holds a participation interest may,
either at its own election or pursuant to terms of the loan documentation,
prepay amounts of the loan from time to time. There is no assurance that the
Portfolio will be able to reinvest the proceeds of any loan prepayment at the
same interest rate or on the same terms as those of the original loan
participation.
Corporate loans in which a Portfolio may purchase a loan participation or
assignment are made generally to finance internal growth, mergers, acquisitions,
stock repurchases, leveraged buy-outs, and other corporate activities. The
highly leveraged capital structure of the borrowers in certain of these
transactions may make such loans especially vulnerable to adverse changes in
economic or market conditions.
Certain of the loan participations or assignments acquired by a Portfolio may
involve unfunded commitments of the lenders or revolving credit facilities under
which a borrower may from time to time borrow and repay amounts up to the
maximum amount of the facility. In such cases, the Portfolio would have an
obligation to advance its portion of such additional borrowings upon the terms
specified in the loan documentation.
INDEXED SECURITIES AND STRUCTURED NOTES
The values of indexed securities and structured notes are linked to currencies,
other securities, interest rates, commodities, indices or other financial
indicators ("reference instruments"). These instruments differ from other types
of debt securities in several respects. The interest rate or principal amount
payable at maturity may vary based on changes in one or more specified reference
instruments, such as a floating interest rate compared with a fixed interest
rate or the currency exchange rates between two currencies (neither of which
need be the currency in which the instrument is denominated). An indexed
security or structured note may be positively or negatively indexed; that is,
its value or interest rate may increase or decrease if the value of the
reference instrument increases. Further, the change in the principal amount
payable with respect to, or the interest rate of, an indexed security or
structured note may be a multiple of the percentage change (positive or
negative) in the value of the underlying reference instrument(s).
Investment in indexed securities and structured notes involves certain risks,
including the credit risk of the issuer and the normal risks of price changes in
response to changes in interest rates. Further, in the case of certain indexed
securities or structured notes, a decline in the reference instrument may cause
the interest rate to be reduced to zero, and any further declines in the
reference instrument may then reduce the principal amount payable on maturity.
Finally, these securities may be less liquid than other types of securities, and
may be more volatile than their underlying reference instruments.
FORWARD COMMITMENTS
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Each Portfolio may enter into commitments to purchase securities on a "forward
commitment" basis, including purchases on a "when-issued" basis or a "to be
announced" basis. When such transactions are negotiated, certain terms may be
fixed at the time the commitment is made, but delivery and payment for the
securities takes place at a later date. Such securities are often the most
efficiently priced and have the best liquidity in the bond market. During the
period between a commitment and settlement, no payment is made by the purchaser
for the securities purchased and, thus, no interest accrues to the purchaser
from the transaction. In a "to be announced" transaction, a Portfolio commits to
purchase securities for which all specific information is not yet known at the
time of the trade, particularly the exact face amount in forward commitment
mortgage-backed securities transactions.
A Portfolio may sell the securities subject to a forward commitment purchase,
which may result in a gain or loss. When a Portfolio purchases securities on a
forward commitment basis, it assumes the risks of ownership, including the risk
of price fluctuation, at the time of purchase, not at the time of receipt.
Purchases of forward commitment securities also involve a risk of loss if the
seller fails to deliver after the value of the securities has risen. Depending
on market conditions, a Portfolio's forward commitment purchases could cause its
net asset value to be more volatile.
Each Portfolio may also enter into a forward commitment to sell securities it
owns and will generally do so only with the intention of actually delivering the
securities. The use of forward commitments enables a Portfolio to hedge against
anticipated changes in interest rates and prices. In a forward sale, a Portfolio
does not participate in gains or losses on the security occurring after the
commitment date. Forward commitments to sell securities also involve a risk of
loss if the seller fails to take delivery after the value of the securities has
declined.
Forward commitment transactions involve additional risks similar to those
associated with investments in options and futures contracts. See "Options and
Futures Contracts." It is not expected that any Portfolio's purchases of forward
commitments will at any time exceed, in the aggregate, 20% of that Portfolio's
total assets.
RESTRICTED AND ILLIQUID SECURITIES
Restricted securities are securities subject to legal or contractual
restrictions on their resale, such as private placements. Such restrictions
might prevent the sale of restricted securities at a time when the sale would
otherwise be desirable. No securities for which there is not a readily available
market ("illiquid securities") will be acquired by any Portfolio if such
acquisition would cause the aggregate value of illiquid securities to exceed 15%
of the Portfolio's net assets (10% of net assets for the Western Asset Money
Market Portfolio and the Western Asset Government Money Market Portfolio).
Under SEC regulations, certain securities acquired through private placements
can be traded freely among qualified purchasers. The SEC has stated that an
investment company's board of directors, or its investment adviser acting under
authority delegated by the board, may determine that a security eligible for
trading under this rule is "liquid." The Portfolios intend to rely on this rule,
to the extent appropriate, to deem specific securities acquired through private
placement as "liquid." The Boards have delegated to a Portfolio's Adviser the
responsibility for determining whether a particular security eligible for
trading under this rule is "liquid." Investing in these restricted securities
could have the effect of increasing a Portfolio's illiquidity if qualified
purchasers become, for a time, uninterested in buying these securities.
Restricted securities may be sold only (1) pursuant to SEC Rule 144A or other
exemption, (2) in privately negotiated transactions or (3) in public offerings
with respect to which a registration statement is in effect under the Securities
Act of 1933, as amended. Rule 144A securities, although not registered in the
U.S., may be sold to qualified institutional buyers in accordance with Rule 144A
under the Securities Act of 1933, as amended. Each Portfolio's Adviser, acting
pursuant to guidelines established by its Board of Directors, may determine that
some Rule 144A securities are liquid for purposes of limitations on the amount
of illiquid investments a Portfolio may own. Where registration is required, a
Portfolio may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Portfolio may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, the Portfolio might obtain a less favorable price than prevailed
when it decided to sell.
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<PAGE>
Illiquid securities may be difficult to value, and a Portfolio may have
difficulty disposing of such securities promptly. The Portfolios do not consider
foreign securities to be restricted if they can be freely sold in the principal
markets in which they are traded, even if they are not registered for sale in
the U.S.
SECURITIES OF OTHER INVESTMENT COMPANIES
Investments in other investment companies may involve the payment of substantial
premiums above the net asset value of such issuers' portfolio securities, and
the total return on such investments will be reduced by the operating expenses
and fees of such investment companies, including advisory fees. The Portfolios
may invest in both closed-end and open-end investment companies.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement under which securities are acquired from
a securities dealer or bank subject to resale at an agreed upon price and date.
The securities are held by a Portfolio as collateral until retransferred and
will be supplemented by additional collateral if necessary to maintain a total
market value equal to or in excess of the value of the repurchase agreement. The
Portfolio bears a risk of loss in the event that the other party to a repurchase
agreement defaults on its obligations and the Portfolio is delayed or prevented
from exercising its rights to dispose of the collateral securities. A Portfolio
also bears the risk that the proceeds from any sale of collateral will be less
than the repurchase price. Repurchase Agreements may be viewed as a loan by a
Portfolio.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING
A reverse repurchase agreement is a portfolio management technique in which a
Portfolio temporarily transfers possession of a portfolio instrument to another
person, such as a financial institution or broker-dealer, in return for cash. At
the same time, the Portfolio agrees to repurchase the instrument at an agreed
upon time (normally within seven days) and price, including interest payment.
While engaging in reverse repurchase agreements, each Portfolio will maintain
cash or securities in a segregated account at its custodian bank with a value at
least equal to the Portfolio's obligation under the agreements, adjusted daily.
Reverse repurchase agreements may expose a Portfolio to greater fluctuations in
the value of its assets and renders the segregated assets unavailable for sale
or other disposition. Reverse Repurchase Agreements may be viewed as a borrowing
by a Portfolio.
The Portfolios may also enter into dollar roll transactions in which a Portfolio
sells a fixed income security for delivery in the current month and
simultaneously contracts to purchase substantially similar (same type, coupon
and maturity) securities at an agreed upon future time. By engaging in the
dollar roll transaction the Portfolio foregoes principal and interest paid on
the security that is sold, but receives the difference between the current sales
price and the forward price for the future purchase. The Portfolio would also be
able to earn interest on the income that is received from the initial sale.
The obligation to purchase securities on a specified future date involves the
risk that the market value of the securities that a Portfolio is obligated to
purchase may decline below the purchase price. In addition, in the event the
other party to the transaction files for bankruptcy, becomes insolvent or
defaults on its obligation, a Portfolio may be adversely affected.
Each Portfolio will limit its investments in reverse repurchase agreements and
other borrowing (including dollar roll transactions) to no more than one-third
of its total assets. To avoid potential leveraging effects of such borrowing, a
Portfolio will not make investments while its borrowing (including reverse
repurchase agreements but excluding dollar rolls) is in excess of 5% of its
total assets. To avoid potential leveraging effects of dollar rolls, each
Portfolio will segregate assets as required by the Investment Company Act of
1940.
The 1940 Act requires a Portfolio to maintain continuous asset coverage (that
is, total assets including borrowings, less liabilities exclusive of borrowings)
of at least 300% of the amount borrowed. If the asset coverage should decline
below 300% as a result of market fluctuations or for other reasons, a Portfolio
may be required to sell some of its holdings within three days to reduce the
debt and restore the 300% asset coverage, even though it may be disadvantageous
from
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<PAGE>
an investment standpoint to sell securities at that time. Borrowing may increase
the effect on net asset value of any increase or decrease in the market value of
the Portfolio.
Money borrowed will be subject to interest costs which may or may not be
recovered by appreciation of the securities purchased. A Portfolio also may be
required to maintain minimum average balances in connection with such borrowing
or to pay a commitment or other fee to maintain a line of credit; either of
these requirements would increase the cost of borrowing over the stated interest
rate. The Portfolios may enter into reverse repurchase agreements and dollar
roll transactions as a method of borrowing.
LOANS OF PORTFOLIO SECURITIES
A Portfolio may lend its portfolio securities, provided that cash or equivalent
collateral, equal to at least 100% of the market value of the securities loaned,
is continuously maintained by the borrower with the Portfolio. During the time
securities are on loan, the borrower will pay the Portfolio an amount equivalent
to any dividends or interest paid on such securities, and the Portfolio may
invest the cash collateral and earn additional income, or it may receive an
agreed upon amount of interest income from the borrower who has delivered
equivalent collateral. These loans are subject to termination at the option of
the Portfolio or the borrower. A Portfolio may pay administrative and custodial
fees in connection with a loan and may pay a negotiated portion of the interest
earned on the cash or equivalent collateral to the borrower or placing broker.
No Portfolio presently expects to have on loan at any given time securities
totaling more than one-third of its net assets. A Portfolio runs the risk that
the counterparty to a loan transaction will default on its obligation and that
the value of the collateral received may decline before the Portfolio can
dispose of it.
DURATION
Duration is a measure of the expected life of a fixed income security on a cash
flow basis. Duration takes the time intervals over which the interest and
principal payments are scheduled and weights each by the present values of the
cash to be received at the corresponding future point in time. For any fixed
income security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, a current coupon
bond with a maturity of 3.5 years will have a duration of approximately three
years. In general, the lower the stated or coupon rate of interest of a fixed
income security, the longer its duration; conversely, the higher the stated or
coupon rate of interest of a fixed income security, the shorter its duration.
There may be circumstances under which even duration calculations do not
properly reflect the interest rate exposure of a security. For example, floating
variable rate securities may have final maturities of ten or more years;
however, their interest exposure corresponds to the frequency of the coupon
reset. Similarly, many mortgage pass-through securities may have stated final
maturities of 30 years, but current prepayment rates are more critical in
determining the security's interest rate exposure. In these situations, the
Adviser may consider other analytical techniques that incorporate the economic
life of a security into its determination of interest rate exposure.
PORTFOLIO TURNOVER
The turnover rates of the Western Asset Limited Duration Portfolio, the Western
Asset Intermediate Portfolio, the Western Asset Core Portfolio, and the Western
Asset Core Plus Portfolio and the Western Asset Non-U.S. Fixed Income Portfolio
for the fiscal year ended March 31, 1999 on an annualized basis were 321.3%,
389.6, 484.3%, 565.7% and 388%, respectively. While it is impossible to predict
portfolio turnover rates, the Western Asset Enhanced Equity Portfolio, the
Western Asset Intermediate Plus Portfolio, the Western Asset High Yield
Portfolio, and the Western Asset Global Strategic Income Portfolio expect that
their average turnover rate will not exceed 400%, 400%, 200% and 200%,
respectively.
The length of time a Portfolio has held a particular security is not generally a
consideration in investment decisions. A change in the securities held by a
Portfolio is known as "portfolio turnover." As a result of a Portfolio's
investment policies, under certain market conditions a Portfolio's portfolio
turnover rate may be higher than that of other mutual funds. Portfolio turnover
generally involves some expense to a Portfolio, including brokerage commissions
or dealer
-23-
<PAGE>
mark-ups and other transaction costs on the sale of securities and reinvestment
in other securities. These transactions may result in realization of taxable
capital gains. Higher portfolio turnover rates, such as those above 100%, are
likely to result in higher brokerage commissions or other transactions costs and
could give rise to a greater amount of taxable capital gains.
ALTERNATIVE INVESTMENT STRATEGIES
At times a Portfolio's Adviser may judge that conditions in the securities
markets make pursuing the Portfolio's typical investment strategy inconsistent
with the best interests of its shareholders. At such times, the Adviser may
temporarily use alternative strategies, primarily designed to reduce
fluctuations in the value of the Portfolio's assets. In implementing these
defensive strategies, a Portfolio may invest without limit in a variety of
securities that the Adviser believes present less risk to a Portfolio, including
equity securities, debt securities, preferred stocks, U.S. Government and agency
obligations, cash or money market instruments, or in other securities the
Adviser considers consistent with such defensive strategies. As a result of
these strategies, the Portfolios may invest up to 100% of their assets in
securities of U.S. issuers. It is impossible to predict when, or for how long, a
Portfolio will use these alternative strategies.
NEW INVESTMENT PRODUCTS
New types of mortgage-backed and asset-backed securities, derivative instruments
and hedging instruments are developed and marketed from time to time. Consistent
with its investment limitations, each Portfolio expects to invest in those new
types of securities and instruments that its Adviser believes may assist the
Portfolio in achieving its investment objective.
INVESTMENT POLICIES
The investment objective of each of the Western Asset Core, the Western Asset
Limited Duration, the Western Asset Intermediate and the Western Asset Money
Market Portfolio are "fundamental." Except for investment policies designated as
fundamental in this Prospectus or the SAI, the investment policies described in
this Prospectus and in the SAI are not fundamental policies. Changes to
fundamental investment policies require shareholder approval; the Directors may
change any non-fundamental investment policy without shareholder approval.
RATINGS OF DEBT OBLIGATIONS
Moody's, S&P and NRSROs are private organizations that provide ratings of the
credit quality of debt obligations. A description of the ratings assigned to
corporate debt obligations by Moody's and S&P is included as Appendix A to the
Prospectus. A Portfolio may consider these ratings in determining whether to
purchase, sell or hold a security. Ratings are not absolute assurances of
quality. Consequently, securities with the same maturity, interest rate and
rating may have different market prices. Credit rating agencies attempt to
evaluate the safety of principal and interest payments and do not evaluate the
risks of fluctuations in market value. Also, rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that an
issuer's current financial condition may be better or worse than the rating
indicates.
VALUATION OF PORTFOLIO SHARES
As described in the Prospectus, securities owned by any of the Portfolios (other
than the Money Market Portfolios) for which market quotations are readily
available are valued at current market value. Securities are valued at the last
sale price for a comparable position on the day the securities are being valued
or, lacking any sales on such day, at the last available bid price. In cases
where securities are traded on more than one market, the securities are
generally valued on the market considered by the Adviser as the primary market.
Occasionally, events affecting the value of foreign investments occur between
the time at which they are determined and the close of trading on the Exchange,
which events will not be reflected in a computation of a Portfolio's net asset
value on that day. If events materially affecting the value of such investments
occur during such time period, the
-24-
<PAGE>
investments will be valued at their fair value as determined in good faith by,
or under the direction of, the Board of Directors.
USE OF THE AMORTIZED COST METHOD BY THE MONEY MARKET PORTFOLIOS
The Board of Directors of the Money Market Portfolios has decided that the best
method for determining the value of securities held by the Money Market
Portfolios is amortized cost. Under this method, portfolio instruments are
valued at acquisition cost as adjusted for amortization of premium or accrual of
discount rather than at current market value. The Board of Directors continually
assesses this method of valuation and recommends changes where necessary to
assure that the Money Market Portfolios' investments are valued at their fair
value as determined in good faith by, or under the direction of, the Directors.
The Money Market Portfolios' use of the amortized cost method of valuing
portfolio instruments held by it depends on its compliance with Rule 2a-7 under
the 1940 Act. Under that Rule, the Board of Directors must establish procedures
reasonably designed to stabilize the net asset value per share at $1.00 per
share, taking into account current market conditions and the Portfolio's
investment objective.
MONITORING PROCEDURES
The Board of Directors' procedures include monitoring the relationship between
the amortized cost value per share and a net asset value per share based upon
available indications of market value. The Board will take any steps it
considers appropriate if there is a difference of more than 0.5% between the two
(such as redeeming in kind or shortening the average portfolio maturity) to
minimize any material dilution or other unfair results arising from differences
between the two methods of determining net asset value.
INVESTMENT RESTRICTIONS
Rule 2a-7 requires each Money Market Portfolio to limit its investments to
instruments that present minimal credit risk, in the opinion of the Board, and
are of high quality. The Rule also requires each Money Market Portfolio to
maintain a dollar-weighted average portfolio maturity of not more than 90 days
that is appropriate to the objective of maintaining a stable net asset value of
$1.00 per share. In addition, no instrument considered under SEC rules to have a
remaining maturity of more than 397 days can be purchased by the Money Market
Portfolios. The Money Market Portfolios may hold securities with maturities
greater than 397 days as collateral for repurchase agreements and other
collateralized transactions of short duration. Should the disposition of a
portfolio security result in a dollar-weighted average portfolio maturity of
more than 90 days, the relevant Money Market Portfolio will invest its available
cash to reduce the average maturity to 90 days or less as soon as possible.
In periods of declining interest rates, the indicated daily yield on shares of
each Money Market Portfolio computed by dividing the annualized daily income on
the portfolio by the net asset value computed as above may tend to be higher
than a similar computation made by using a method of valuation based upon market
prices and estimates. In periods of rising interest rates, the indicated daily
yield on shares of each Money Market Portfolio computed the same way may tend to
be lower than a similar computation made by using a method of calculation based
upon market prices and estimates.
MANAGEMENT OF THE PORTFOLIOS
DIRECTORS AND OFFICERS
The Fund's officers are responsible for the operation of the Fund under the
direction of its Board of Directors. The officers and Directors of the Fund and
their principal occupations during the past five years are set forth below. An
asterisk (*) indicates Interested Directors.
DIRECTORS AND OFFICERS; LM INSTITUTIONAL FUND ADVISORS I, INC.
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<PAGE>
The address of each officer and Director of LM Institutional Fund Advisors I,
Inc. is 117 East Colorado Blvd., Pasadena, CA 91105, unless otherwise stated.
William G. McGagh, 67(1,2,3), Chairman of the Board and Director; Consultant,
McGagh Associates (corporate financial consulting), January 1989-present;
Director of Pacific American Income Shares, Inc.; formerly: Senior
Vice-President, Chief Financial Officer and Director of Northrop Corporation
(military aircraft).
*W. Curtis Livingston, III, 53(1), Director; Director of Western Asset
(investment management firm), March 1999-present; President, Director and Chief
Executive Officer of Western Asset, December 1980 - March 1999; President,
Pacific American Income Shares, Inc.
*Ronald L. Olson, 55(2, 4), Director; Senior Partner, Munger, Tolles & Olson (a
law partnership); Director of Pacific American Income Shares, Inc.
Louis A. Simpson, 59, Director; President and CEO Capital Operations of
Government Employees Insurance Company (GEICO Corporation) since May 1993; Vice
Chairman of GEICO (1985- 1993); Senior Vice President and Chief Investment
Officer of GEICO (1979-1985). Director of Pacific American Income Shares, Inc.,
Potomac Electric Power Company, Potomac Capital Investment Corporation, and U.S.
West Formerly: President and CEO of Western Asset.
Ronald J. Arnault; 54, Director; President of RJA Consultants (energy industry
financial consulting); member, Board of Governors of The Music Center of Los
Angeles and the Center Theatre Group. Formerly: Executive Vice President, Chief
Financial Officer and Director of ARCO; Director of Pacific American Income
Shares, Inc.
William E. B. Siart, 50, Director; Director of Pacific American Income Shares,
Inc. Formerly: Chairman (1995-1996), Chief Executive Officer (1995-1996),
President (1990- 1996) of First Interstate Bancorp. Member of the Board of
Trustees of the University of Southern California.
John E. Bryson, 54, Director; Chairman and Chief Executive Officer of Edison
International and its principal subsidiary, Southern California Edison, since
October 1990. Also a director of Pacific American Income Shares, Inc., The
Boeing Company, The Times Mirror Company, H.F. Ahmanson & Co., and the W.M. Keck
Foundation, and a trustee of Stanford University.
Anita L. DeFrantz, 45, Director; President of the Amateur Athletic Foundation of
Los Angeles, since, 1985; President of Kids in Sports, since 1994; Vice
President of the International Olympic Committee, since 1997. Also, a director
of Pacific American Income Shares, Inc., and a board member of the Amateur
Athletic Foundation of Los Angeles, since 1985, International Olympic Committee,
since 1996, and the United States Olympic Committee Executive Board, since 1977.
Edward A. Taber III, 54, Director; Senior Executive Vice President and Head of
Asset Management, Legg Mason, Inc., since 1992. Formerly, Director and Head of
Taxable Fixed Income Division, T. Rowe Price Associates (1973-1992). Also, a
director of Western Asset Management Company, Western Asset Global Management
Limited, Bartlett & Co., Batterymarch Financial Management, Inc., Gray, Seifert
& Co., Inc., GSH & Co., Inc., Fairfield Group, Inc., and Legg Mason Fund
Advisors, Inc.
Carl L. Eichstaedt, 36, Vice-President; Portfolio Manager of Western Asset since
1994; formerly: Senior Partner, Portfolio Manager of Harris Investment
Management, 1993-1994; Portfolio Manager of Pacific Investment Management
Company, 1992-1993; Director Fixed Income of Security Pacific Investment
Managers, 1990-1992; and Vice President of Chemical Securities, Inc., 1986-1990.
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<PAGE>
Kent S. Engel, 49, Vice-President; Director and Chief Investment Officer of
Western Asset, 1969-present; Vice-President and Portfolio Manager of Pacific
American Income Shares, Inc.
Keith J. Gardner, 39, Vice-President; Portfolio Manager of Western Asset since
1994; formerly: Senior Portfolio Manager of Legg Mason, Inc., 1992-1994;
Portfolio Manager of T. Rowe Price Associates, Inc., 1985-1992.
Scott F. Grannis, 47, Vice-President; Director and Economist, Western Asset,
1989 - present; Director, Supershares Services Corp. (investment company
services); formerly: Vice-President, Leland O'Brien Rubinstein (investment
advisory firm), 1986-89.
Ilene S. Harker, 41, Vice-President; Director of Administration and Controls,
Western Asset, 1978-present; Vice President, Pacific American Income Shares,
Inc., since April 1996; Formerly: Assistant Secretary of the Fund and Secretary
of Pacific American Income Shares, Inc., 1993-1996.
James W. Hirschmann, III, 36, President; President and Chief Executive Officer,
Western Asset, March 1999 present; Director of Marketing, Western Asset, April
1989-March 1999; formerly: Vice-President and Director of Marketing, Financial
Trust Corporation (bank holding company), January 1988 - April 1989;
Vice-President of Marketing, Atalanta/Sosnoff Capital (investment management
company), January 1986 - January 1988.
Randolph L. Kohn, 49, Vice-President; Director of Client Services, Western
Asset, 1984-present.
S. Kenneth Leech, 42, Vice-President; Director of Portfolio Management, Western
Asset, May 1990-present; formerly: Senior Trader of Greenwich Capital,
1988-1990; Fixed Income Manager of The First Boston Corporation (holding
company; stock and bond dealers), 1985-1987.
Edward A. Moody, 46, Vice-President; Director and Portfolio Manager, Western
Asset.
Joseph L. Orlando, 36, Vice-President; Marketing Executive of Western Asset;
formerly: Regional Manager of T. Rowe Price Associates (investment management
firm), January 1988 - July 1992.
Marie K. Karpinski, 49, Vice President and Treasurer; Vice President and
Treasurer of twenty-one Legg Mason/Bartlett funds (open-end investment
companies), 1986-present: Vice President and Treasurer of LM Institutional Fund
Advisors I, Inc.; Assistant Treasurer of Pacific American Income Shares, Inc.
(closed-end investment company), 1988-present; Treasurer of Legg Mason Fund
Adviser, Inc., March 1986-present; Vice-President of Legg Mason Wood Walker,
Incorporated., 1992-present; Assistant Vice-President of Legg Mason Wood Walker,
Incorporated, 1989-1992.
Steven T. Saruwatari, 31, Assistant Treasurer; Senior Financial Officer, Western
Asset; formerly: Controller-Finance for LaSalle Paper Company/Spicers Paper,
Inc. (distributor of fine printing papers), June 1991-November 1994; and Senior
Auditor for Coopers and Lybrand (international public accounting firm),
September 1988 - May 1991.
Stephen A. Walsh, 37, Vice-President; Director and Portfolio Manager, Western
Asset; formerly: Portfolio Manager and Trader of Security Pacific Investment
Managers, Inc. (investment management company), 1989-1991.
- --------------------------------------------------------------------------------
(1) Member of the Executive Committee of the Board. When the full Board
is not in session, the Executive Committee may exercise all the powers
held by the Board in the management of the business and affairs of the
Fund that may be lawfully exercised by the full Board, except the power
to declare a dividend, to authorize the issuance of stock, to recommend
to stockholders any matter requiring stockholders' approval, to amend
the By-Laws, or to approve any merger or share exchange which does not
require shareholder approval.
(2) Member of the Audit Committee of the Board. The Audit Committee
meets with the Fund's independent accountants to review the financial
statements of the Fund, the arrangements for special and annual audits,
the adequacy of internal controls, the Fund's periodic reporting
process, material contracts entered into by the Fund, the services
provided by the accountants, any proposed changes in accounting
practices or principles, the independence of the accountants; and to
report on such matters to the Board.
The Fund has no compensation committee.
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<PAGE>
(3) Member of the Nominating Committee of the Board. The Nominating
Committee is responsible for the selection and nomination of
Disinterested Directors.
(4) Mr. Olson may be deemed an interested person because the law firm
in which he is a partner has provided certain services to the Fund and
Western Asset.
Officers and Directors of the Fund who are affiliated persons of the Manager,
Western Asset, LMFA or Legg Mason receive no salary or fees from the Fund. Each
Independent Director of the Fund receives a fee of $2,000 annually for serving
as a Director, and a fee of $500 and related expenses per Portfolio for each
meeting of the Board of Directors attended by them. The Chairman of the Board
receives an additional $1,000 per year for serving in that capacity.
The following table provides certain information relating to the compensation of
the Fund's Directors and senior executive officers for the fiscal year ended
March 31, 1999.
<TABLE>
<CAPTION>
Aggregate Compensation
Total Compensation From the Fund and Complex
Name of Person and Position From the Fund* Paid to Directors**
- --------------------------- -------------- -------------------
<S> <C> <C>
William G. McGagh -
Chairman of the Board and Director $ 11,000 $ 20,100
- ---------------------------------- ---------------------- --------------------------
Ronald J. Arnault - Director $ 9,500 $ 17,000
- ---------------------------- ---------------------- --------------------------
Norman Barker, Jr. - Director *** $ n/a $ 2,800
- ----------------------------- ---------------------- --------------------------
Ronald L. Olson - Director $ 10,000 $ 17,800
- -------------------------- ---------------------- --------------------------
W. Curtis Livingston, III -
Director and President none none
Louis A. Simpson - Director $ 10,000 $ 18,000
- --------------------------- --------------------- --------------------------
William E. B. Siart - Director $ 10,000 $ 17,800
- ------------------------------ --------------------- --------------------------
John E. Bryson $ 9,500 $ 17,300
- -------------- ---------------------- --------------------------
Anita L. DeFrantz $ 10,000 $ 15,500
- ----------------- ---------------------- --------------------------
Dr. Richard L. Gilman *** $ 9,500 $ 17,300
- --------------------- ---------------------- --------------------------
Ilene S. Harker - Vice President none none
- -------------------------------- ---- ----
Steve T. Saruwatari - Assistant Treasurer none none
- ----------------------------------------- ---- ----
</TABLE>
*Represents fees paid to each person during the fiscal year ended March 31,
1999.
**Represents aggregate compensation paid to each person during the calendar year
ended December 31, 1998 for serving as a Director of the Company and of a
closed-end investment company advised by Western Asset. LM Institutional Fund
Advisors II, Inc., an open-end investment company which offers six separate
Portfolios, is also part of the Fund Complex.
*** Messrs. Barker and Gilman retired from the Board in 1998.
MANAGER AND ADVISERS
THE MANAGER. The Manager, a wholly owned subsidiary of Legg Mason, Inc., a
financial services holding company, serves as investment manager to the Fund
under the Investment Management Agreement dated May 29, 1998 between
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<PAGE>
the Manager and the Fund (the "Management Agreement"). The Management Agreement
was most recently approved by the Board of Directors, including a majority of
Independent Directors, on March 6, 1998.
Under the Management Agreement, the Manager is responsible, subject to the
general supervision of the Fund's Board of Directors, for the actual management
of the Fund's assets, including the responsibility for making decisions and
placing orders to buy, sell or hold a particular security, consistent with the
investment objectives and policies described in the Prospectus and this
Statement of Additional Information. The Manager also is responsible for the
compensation of Directors and officers of the Fund who are employees of the
Manager or its affiliates. The Manager receives for its services a fee as
described in the Prospectus. As noted below, the Manager has delegated
responsibility for the selection of the Fund's investments to the Advisers.
Each Portfolio pays all of its other expenses which are not assumed by the
Manager. These expenses include, among others, expenses of preparing and
printing prospectuses, statements of additional information, proxy statements
and reports and of distributing them to existing shareholders, custodian
charges, transfer agency fees, organizational expenses, compensation of the
Directors who are not "interested persons" of the Manager, or its affiliates, as
that term is defined in the 1940 Act, legal and audit expenses, insurance
expenses, expenses of registering and qualifying shares of the Portfolios for
sale under federal and state law, Rule 12b-1 fees, governmental fees, expenses
incurred in connection with membership in investment company organizations,
interest expense, taxes and brokerage fees and commissions. The Portfolios also
are liable for such nonrecurring expenses as may arise, including litigation to
which a Portfolio or the Fund may be a party. The Fund may also have an
obligation to indemnify its Directors and officers with respect to litigation.
Under the Management Agreement, the Manager will not be liable for any error of
judgment or mistake of law or for any loss suffered by the Portfolios in
connection with the performance of the Management Agreement, except a loss
resulting from willful misfeasance, bad faith or gross negligence on its part in
the performance of its duties or from reckless disregard by it of its
obligations or duties thereunder.
The Management Agreement terminates automatically upon assignment and is
terminable with respect to any Portfolio at any time without penalty by vote of
the Fund's Board of Directors, by vote of a majority of that Portfolio's
outstanding voting securities, or by the Manager, on not less than 60 days'
notice to the Fund, and may be terminated immediately upon the mutual written
consent of the Manager and the Fund.
For the Western Asset Core Portfolio, the Manager received $3,113,000 ,
$1,769,000(prior to fees waived of $30,000), $2,007,000 (prior to fees waived of
$22,000) and $1,548,00 (prior to fees waived of $111,000) for the fiscal year
ended March 31, 1999, the nine month period ended March 31, 1998, and the years
ended June 30, 1997 and 1996, respectively. For the Western Asset Intermediate
Portfolio, the Manager received $1,355,000 (prior to fees waived of $101,000),
$663,000(prior to fees waived of $142,000), $569,000(prior to fees waived of
$158,000) and $131,000(prior to fees waived of $131,000 ) for the fiscal year
ended March 31, 1999, the nine month period ended March 31, 1998, and the years
ended June 30, 1997 and 1996, respectively. For the Western Asset Limited
Duration Portfolio, the Manager waived all advisory fees for the fiscal year
ended March 31, 1999, the nine month period ended March 31, 1998, and the year
ended June 30, 1997 and for the period May 1, 1996 (commencement of operations)
to June 30, 1996. For the Western Asset Core Plus Portfolio, the Manager
received $286,000 (prior to fees waived of $95,000), for the initial period
ended March 31, 1999. For the Western Asset Non-U.S. Fixed Income Portfolio, the
Manager received $191,000 (prior to fees waived of $127,000 for the initial
period ended March 31, 1999.
ADVISERS
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<PAGE>
WESTERN ASSET. Western Asset, a wholly owned subsidiary of Legg Mason, Inc.,
serves as Adviser to the Western Asset Enhanced Equity Portfolio, the Western
Asset Money Market Portfolio, the Western Asset Government Money Market
Portfolio, the Western Asset Limited Duration Portfolio, the Western Asset
Intermediate Portfolio, the Western Asset Intermediate Plus Portfolio, the
Western Asset Core Portfolio, the Western Asset Core Plus Portfolio, the Western
Asset High Yield Portfolio and the Western Asset Global Strategic Income
Portfolio (U.S. portion) under an Investment Advisory Agreement dated May 26,
1998 between Western Asset and the Manager (the "Western Asset Advisory
Agreement"). The Western Asset Advisory Agreement was most recently approved by
the Board of Directors, including a majority of the Independent Directors, on
March 6, 1998.
Under the Western Asset Advisory Agreement, Western Asset is responsible,
subject to the general supervision of the Fund's Board of Directors and the
Manager, for the actual management of the Portfolios' assets, including the
responsibility for making decisions and placing orders to buy, sell or hold a
particular security, consistent with the investment objectives and policies
described in the Prospectus and this Statement of Additional Information.
Western Asset receives from the Manager for its services an advisory fee as
described in the Prospectus.
Under the Western Asset Advisory Agreement, Western will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Portfolios
in connection with the performance of the Western Asset Advisory Agreement,
except a loss resulting from willful misfeasance, bad faith or gross negligence
on its part in the performance of its duties or from reckless disregard by it of
its obligations or duties thereunder.
The Western Asset Advisory Agreement terminates automatically upon assignment
and is terminable with respect to any Portfolio at any time without penalty by
vote of the Fund's Board of Directors, by vote of a majority of that Portfolio's
outstanding voting securities, or by Western Asset, on not less than 60 days'
notice, and may be terminated immediately upon the mutual written consent of the
parties.
Western Asset served as investment adviser to LM Institutional Fund Advisors I,
Inc. under an Investment Advisory Agreement dated August 24, 1990, and as
amended on February 8, 1996, between Western Asset and the Fund covering the
Western Asset Limited Duration Portfolio and Western Asset Core Portfolio
("Advisory Agreement I"), an Investment Advisory Agreement dated February 10,
1994, and as amended on February 8, 1996, between Western Asset and the LM
Institutional Fund Advisors I, Inc. covering the Western Asset Intermediate
Portfolio ("Advisory Agreement II"), and an Investment Advisory Agreement dated
June 30, 1992, between Western Asset and the LM Institutional Fund Advisors I,
Inc. covering the Western Asset International Securities Portfolio. The rate of
compensation payable to Western Asset under Advisory Agreement I and Advisory
Agreement II was the same as that payable to the Manager with respect to the
relevant Portfolios.
WAGM. WAGM, a wholly owned subsidiary of Legg Mason, Inc., serves as Adviser to
the Western Asset Non-U.S. Fixed Income Portfolio, and to the non-U.S. portion
of the Western Asset Intermediate Plus Portfolio, the Western Asset Core Plus
Portfolio and the Western Asset Global Strategic Income Portfolio under an
Investment Advisory Agreement dated May 26, 1998 between the Manager and WAGM
(the "WAGM Advisory Agreement"). The WAGM Advisory Agreement was most recently
approved by the Board of Directors, including a majority of the Independent
Directors, on March 6, 1998.
Under the WAGM Advisory Agreement, WAGM is responsible, subject to the general
supervision of the Fund's Board of Directors and the Manager, for the actual
management of the Portfolio's assets, including the responsibility for making
decisions and placing orders to buy, sell or hold a particular security,
consistent with the investment objective and policies described in the
Prospectus and this Statement of Additional Information. WAGM also is
responsible for the compensation of Directors and officers of the Fund who are
employees of WAGM or its affiliates. WAGM receives from the Manager for its
services to the Portfolio an advisory fee as described in the Prospectus.
Under the WAGM Advisory Agreement, WAGM will not be liable for any error of
judgment or mistake of law or for any loss suffered by the Portfolio in
connection with the performance of the WAGM Advisory Agreement, except a loss
resulting from willful misfeasance, bad faith or gross negligence on its part in
the performance of its duties or from reckless disregard by it of its
obligations or duties thereunder.
-30-
<PAGE>
The WAGM Advisory Agreement terminates automatically upon assignment and is
terminable at any time without penalty by vote of the Fund's Board of Directors,
by vote of a majority of the Portfolio's outstanding voting securities, or by
WAGM, on not less than 60 days' notice, and may be terminated immediately upon
the mutual written consent of the parties.
DISTRIBUTORS
Legg Mason, 100 Light Street, P. O. Box 1476, Baltimore, MD 21203-1476, acts as
a distributor of the shares of LM Institutional Fund Advisors I, Inc. pursuant
to an Underwriting Agreement with the Fund dated August 24, 1990 and amended May
26, 1998 (the "Underwriting Agreement").
Legg Mason is not obligated to sell any specific amount of Fund shares and
receives no compensation pursuant to the Underwriting Agreement. The
Underwriting Agreement is terminable with respect to any Portfolio without
penalty, at any time, by vote of a majority of the Fund's Independent Directors,
or by vote of the holders of a majority of the shares of that Portfolio, or by
Legg Mason upon 60 days' notice to the Fund.
The Fund has adopted a Plan which, among other things, permits the Fund to pay
Legg Mason fees for its services related to sales and distribution of Financial
Intermediary Class shares and the provision of ongoing services to Financial
Intermediary Class shareholders. Payments are made only from assets attributable
to Financial Intermediary Class shares. Under the Plan, the aggregate fees may
not exceed an annual rate of 0.40% (currently limited to 0.25%) of each
Portfolio's average daily net assets attributable to Financial Intermediary
Class shares. Fees for the Western Asset Money Market Portfolio and the Western
Asset Government Money Market Portfolio are additionally currently limited to
the annual rate of 0.10% of average daily net assets attributable to Financial
Intermediary Class shares. Distribution activities for which such payments may
be made include, but are not limited to, compensation to persons who engage in
or support distribution and redemption of Shares, printing of prospectuses and
reports for persons other than existing shareholders, advertising, preparation
and distribution of sales literature, overhead, travel and telephone expenses,
all with respect to Financial Intermediary Class shares only.
The Plan was approved by Legg Mason Fund Adviser, Inc., as sole shareholder of
the Financial Intermediary Class of each Portfolio on May 17, 1999. Legg Mason
may pay all or a portion of the fee to its investment executives.
The Plan will continue in effect only so long as it is approved at least
annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 Directors, cast in person at a meeting called for the
purpose of voting on the Plan. The Plan may be terminated by a vote of a
majority of the 12b-1 Directors or by a vote of a majority of the outstanding
voting securities of the Financial Intermediary Class shares. Any change in the
Plan that would materially increase the distribution cost to a Portfolio
requires shareholder approval; otherwise the Plan may be amended by the
Directors, including a majority of the 12b-1 Directors, as previously described.
In accordance with Rule 12b-1, the Plan provides that Legg Mason will submit to
the Fund's Board of Directors, and the Directors will review, at least
quarterly, a written report of any amounts expended pursuant to the Plan and the
purposes for which expenditures were made. In addition, as long as the Plan is
in effect, the selection and nomination of the Independent Directors will be
committed to the discretion of such Independent Directors.
For the fiscal year ended March 31, 1999, the Western Asset Limited Duration
Portfolio, Western Asset Intermediate Portfolio, Western Asset Core Portfolio,
Western Asset Core Plus Portfolio and Western Asset Non-U.S. Fixed Income
Portfolio did not pay any distribution and service fees under the plan.
-31-
<PAGE>
Arroyo Seco, Inc. ("Arroyo Seco"), 117 East Colorado Boulevard, Pasadena, CA
91105, a wholly owned subsidiary of Western Asset, is also authorized to offer
the shares of LM Institutional fund Advisors I, Inc. for sale to its customers
pursuant to an Agreement dated November 9, 1995. This Agreement was most
recently approved by the Board of Directors of LM Institutional Fund Advisors I,
Inc., including a majority of the Independent Directors, on May 17, 1998.
LM Institutional Fund Advisors I, Inc. makes no payments to Arroyo Seco in
connection with the offer or sale of the Fund's shares, and Arroyo Seco does not
collect any commissions or other fees from customers in connection with the
offer or sale of the Fund's shares. Arroyo Seco is not obligated to sell any
specific amount of Fund shares. The Agreement is terminable without penalty, at
any time, by vote of a majority of the Fund's Directors, a majority of the
Fund's Independent Directors, or a majority of the Fund's outstanding shares, or
by Arroyo Seco upon 60 days' notice to the Fund.
PURCHASES AND REDEMPTIONS
The Fund reserves the right to modify or terminate the mail, telephone or wire
redemption services described in the Prospectus at any time. The Fund also
reserves the right to suspend or postpone redemptions (1) for any period during
which the Exchange is closed (other than for customary weekend and holiday
closings), (2) when trading in markets the Fund normally utilizes is restricted
or an emergency, as defined by rules and regulations of the SEC, exists, making
disposal of the Fund's investments or determination of its net asset value not
reasonably practicable, or (3) for such other periods as the SEC by regulation
or order may permit for the protection of the Fund's shareholders. In the case
of any such suspension, an investor may either withdraw the request for
redemption or receive payment based upon the net asset value next determined
after the suspension is lifted.
The Fund agrees to redeem shares of each Portfolio solely in cash up to the
lesser of $250,000 or 1% of the relevant Portfolio's net assets during any
90-day period for any one shareholder. In consideration of the best interests of
the remaining shareholders, the Fund reserves the right to pay any redemption
price exceeding this amount in whole or in
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<PAGE>
part by a distribution in kind of readily marketable securities held by a
Portfolio in lieu of cash. It is highly unlikely that shares would ever be
redeemed in kind. If shares are redeemed in kind, however, the redeeming
shareholder should expect to incur transaction costs upon the disposition of the
securities received in the distribution.
EXCHANGE PRIVILEGE
Shareholders in any of the Portfolios are entitled to exchange their shares for
shares of the other Portfolios or of any portfolio of LM Institutional Fund
Advisors II, Inc., provided that such shares are eligible for sale in the
shareholder's state of residence, and are being offered at the time.
When a shareholder decides to exchange shares of a Portfolio, the Fund's
transfer agent will redeem shares of the Portfolio and invest the proceeds in
shares of the Portfolio selected. Redemptions of shares of the Portfolio will be
made at their net asset value determined on the same day that the request is
received in proper order, if received before the close of business of the
Exchange. If the request is received by the transfer agent after the close of
business on the Exchange, shares will be redeemed at their net asset value
determined as of the close of the Exchange on the next day the Exchange is open.
There is no charge for the exchange privilege and no sales charge imposed on an
exchange, but the Portfolios reserve the right to modify or terminate the
exchange privilege at any time. For more information concerning the exchange
privilege, or to make an exchange, please contact the Portfolios.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Under the Advisory Agreements, the Advisers are responsible for the execution of
the Portfolios' transactions. In selecting brokers or dealers, the Advisers must
seek the most favorable price (including the applicable dealer spread) and
execution for such transactions, subject to the possible payment as described
below of higher brokerage commissions or spreads to brokers or dealers who
provide research and analysis. The Portfolios may not always pay the lowest
commission or spread available. Rather, in placing orders on behalf of the
Portfolios, the Advisers will also take into account such factors as size of the
order, difficulty of execution, efficiency of the executing broker's or dealer's
facilities (including the services described below) and any risk assumed by the
executing broker or dealer.
Consistent with the policy of obtaining most favorable price and execution, an
Adviser may give consideration to research, statistical and other services
furnished by brokers or dealers to the Adviser for its use, may place orders
with brokers or dealers who provide supplemental investment and market research
and securities and economic analysis, and may pay to those brokers or dealers a
higher brokerage commission or spread than may be charged by other brokers or
dealers. Such research, analysis and other services may be useful to an Adviser
in connection with services to clients other than the Portfolios. An Adviser's
fee is not reduced by reason of its receiving such brokerage and research
services.
The Portfolios may not buy securities from, or sell securities to, an Adviser or
its affiliated persons as principal, except as permitted by the rules and
regulations of the SEC. Subject to certain conditions, the Portfolios may
purchase securities that are offered in underwritings in which an affiliate of
an Adviser is a participant, although the Portfolios may not make such purchases
directly from such affiliate.
The Advisers will select brokers to execute portfolio transactions. In the
over-the-counter market, the Portfolios generally will deal with responsible
primary market-makers unless a more favorable execution can otherwise be
obtained.
Investment decisions for the Portfolios are made independently from those of
other funds and accounts advised by the Advisers. However, the same security may
be held in the portfolios of more than one fund or account. When two or more
accounts simultaneously engage in the purchase or sale of the same security, the
prices and amounts will be
-33-
<PAGE>
equitably allocated to each account. In some cases, this procedure may adversely
affect the price or quantity of the security available to a particular account.
In other cases, however, an account's ability to participate in larger volume
transactions may produce better executions and prices. Brokerage commissions
paid on transactions were as follows: for the fiscal year ended March 31, 1999,
the nine month period ended March 31, 1998, and the years ended June 30, 1997
and 1996, the Western Asset Core Plus Portfolio paid $33,953, the Western Asset
Core Portfolio paid $514,272, $11,473, $150,548, and $97,148, respectively; the
Western Asset Intermediate Portfolio paid $154,935, $59,910, $50,835 and
$11,655, respectively; the Western Asset Non-U.S. Fixed Income Portfolio paid
$1717, and the Western Asset Limited Duration Portfolio paid $15,525, $7,733,
$7,170 and $0. No brokerage commissions were paid by any Portfolio to affiliated
persons.
ADDITIONAL TAX INFORMATION
GENERAL REQUIREMENTS FOR "PASS-THROUGH" TREATMENT
In order to qualify or continue to qualify for treatment as a regulated
investment company ("RIC") under the Code, each Portfolio must distribute
annually to its shareholders at least 90% of its investment company taxable
income (consisting generally of net investment income and net short-term capital
gain, if any) ("Distribution Requirement") and must meet several additional
requirements. With respect to each Portfolio, these requirements include the
following: (1) the Portfolio must derive at least 90% of its gross income each
taxable year from dividends, interest, payments with respect to securities loans
and gains from the sale or other disposition of securities or other income
(including gains from options or futures ) derived with respect to its business
of investing in securities ("Income Requirement"); (2) at the close of each
quarter of the Portfolio's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. Government securities
and other securities, with those other securities limited, in respect of any one
issuer, to an amount that does not exceed 5% of the value of the Portfolio's
total assets; and (3) at the close of each quarter of the Portfolio's taxable
year, not more than 25% of its total assets may be invested in securities (other
than U.S. Government securities) of any one issuer.
A distribution declared by a Portfolio in December of any year and payable to
shareholders of record on a date in that month will be deemed to have been paid
by the Portfolio and received by the shareholders on December 31 if the
distribution is paid by the Portfolio during the following January. Such a
distribution, therefore, will be taxable to shareholders for the year in which
that December 31 falls.
ORIGINAL ISSUE DISCOUNT
A Portfolio may purchase debt securities issued with original issue discount.
Original issue discount that accrues in a taxable year will be treated as income
earned by the Portfolio and therefore an equivalent amount must be distributed
to satisfy the distribution requirement and avoid imposition of the 4% excise
tax. Because the original issue discount earned by a Portfolio in a taxable year
may not be represented by cash income, the Portfolio may have to dispose of
other securities and use the proceeds thereof to make distributions in amounts
necessary to satisfy those distribution requirements. A Portfolio may realize
capital gains or losses from such dispositions, which would increase or decrease
the Portfolio's investment company taxable income and/or net capital gain. In
addition, any such gains may be realized on the disposition of securities held
for less than three months. Because of the Short-Short Limitation, any such
gains would reduce the Portfolio's ability to sell other securities (and options
and futures), held for less than three months that it might wish to sell in the
ordinary course of its portfolio management.
MISCELLANEOUS
If a Portfolio invests in shares of preferred stock or otherwise holds
dividend-paying securities as a result of exercising a conversion privilege, a
portion of the dividends from the Portfolio's investment company taxable income
(whether paid in cash or reinvested in additional shares) may be eligible for
the dividends-received deduction allowed to corporations. The eligible portion
may not exceed the aggregate dividends received by the Portfolio from U.S.
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<PAGE>
corporations. However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the alternative minimum tax.
If shares of any Portfolio are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital loss
to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any distribution, the shareholder will pay full price for the
shares and receive some portion of the price back as a taxable dividend or
capital gain distribution.
Dividends and interest received by a Portfolio, and gains realized by a
Portfolio on foreign securities, may be subject to income, withholding or other
taxes imposed by foreign countries and U.S. possessions that would reduce the
yield on the Portfolio's securities. Tax conventions between certain countries
and the United States may reduce or eliminate these foreign taxes, however, and
foreign countries generally do not impose taxes on capital gains in respect of
investments by foreign investors.
OTHER INFORMATION
LMIFA I was incorporated in Maryland on May 16, 1990. Prior to May 29, 1998,
LMIFA I was known as "Western Asset Trust, Inc." Each Portfolio is an open-end,
diversified management company, except for Western Asset Non-U.S. Fixed Income
Portfolio and Western Asset Global Strategic Income Portfolio, which are
non-diversified companies. The Directors of LMIFA I may, without shareholder
approval, create, in addition to the Portfolios, other series of shares
representing separate investment portfolios. Any such series may be divided
without shareholder approval into two or more classes of shares having such
terms as the Directors may determine. Establishment and offering of additional
portfolios or classes of shares of a portfolio will not alter the rights of the
Fund's shareholders.
LMIFA I has a total of 13.1 billion shares of common stock at par value $0.001.
Each share has one vote, with fractional shares voting proportionally. Voting on
matters pertinent only to a particular Portfolio, such as the adoption of an
investment advisory contract for that Portfolio, is limited to that Portfolio's
shareholders. Shares of all classes of a Portfolio will vote together as a
single class except when otherwise required by law or as determined by the
Directors. Shares are freely transferable, are entitled to dividends as declared
by the Directors, and, if a Portfolio were liquidated, would receive the net
assets of that Portfolio. Voting rights are not cumulative, and all shares of
the Portfolios are fully paid and nonassessable and have no preemptive or
conversion rights.
Although no Portfolio intends to hold annual shareholder meetings, it will hold
a special meeting of shareholders when the Investment Company Act of 1940 (the
"1940 Act") requires a shareholder vote on certain matters (including the
election of Directors in certain cases or approval of an advisory contract).
When issued, shares are fully paid, non-assessable, redeemable and freely
transferable. Shares do not have preemptive rights or subscription rights. In
liquidation of a Portfolio, each shareholder is entitled to receive his or her
pro rata share of the net assets of that Portfolio.
Prior to May 21, 1998, the Western Asset Core Portfolio was known as the Core
Portfolio; the Western Asset Limited Duration Portfolio was known as the Limited
Duration Portfolio; the Western Asset Intermediate Portfolio was known as the
Intermediate Portfolio; and the Western Asset Money Market Portfolio was known
as the Money Market Portfolio.
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<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
Set forth below is a table which contains the name, address and percentage of
ownership of each person who is known by the Fund to own beneficially five
percent or more of the outstanding shares of the Western Asset Core Portfolio as
of June 30, 1999:
<TABLE>
<CAPTION>
% of Ownership as of
Name and Address June 30, 1999
<S> <C>
Institutional Class
First National Bank of Omaha TTEE 7.24%
One First National Center
Omaha, NE 68102-1596
Newspaper and Mail Deliverers' Publishers' Pension Fund 6.73%
41-18 27th Street
Long Island City, NY 11101-3825
</TABLE>
The following chart contains the name, address and percentage of ownership of
each person who is known by the Fund to own of record five percent or more of
the outstanding shares of the Western Asset Core Plus Portfolio as of June 30,
1999:
<TABLE>
<CAPTION>
<S> <C>
% of Ownership as
Name and Address of June 30, 1999
- ---------------- -----------------
Institutional Class
Thomson Consumer Electron 33.44%
Pension Plan for Employees
Post Office Box 1992
Boston, MA 02105-1992
Appleton Papers Inc. 23.82%
Post Office Box 92956
Chicago, IL 60675-2956
Howard County Community 12.46%
Health Foundation I
10440 Little Patuxent Parkway, Suite 90
Columbia, MD 21044-3629
Blanchard Valley Health 5.69%
Association Pension Plan
Post Office Box 160
Westerville, OH 43086-0160
W E Upjohn Unemployment 5.44%
Trustee Corp
Post Office Box 4042
Kalamazoo, MI 49003-4042
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<PAGE>
Set forth below is a table which contains the name, address and percentage of
ownership of each person who is known by the Fund to own beneficially five
percent or more of the outstanding shares of the Western Asset Intermediate
Portfolio as of June 30, 1999:
% of Ownership as of
Name and Address June 30, 1999
- ---------------- -------------
Financial Intermediary Class
Link & Co. as Trustee for Various 100.00%
401-K Expediter Plans
Post Office Box 630074
Cincinnati, OH 45263-0001
Institutional Class
M A Hanna Master Trust 12.12%
30 South LaSalle Street
Chicago, IL 60603-1006
Anne Arundel County 9.68%
Maryland Master Trust
Post Office Box 1992, Mailstop B2
Boston, MA 02105-1992
Northern Trust Company 8.32%
50 La Salle St.
Chicago, IL 60675
Sun Microsystems Savings Trust 6.61%
209 W. Jackson Boulevard, Suite 700
Chicago, IL 60606-6936
Mt. Sinai Health Care Foundation
Post Office Box 94870
Cleveland, OH 44101-4870 5.69%
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<PAGE>
The following chart contains the name, address and percentage of ownership of
each person who is known by the Fund to own of record five percent or more of
the outstanding shares of the Western Asset Non-U.S. Fixed Income Portfolio as
of June 30, 1999:
% of Ownership as of
Name and Address June 30, 1999
- ---------------- -------------
Institutional Class
Treasurer of the State of Connecticut 61.67%
One Enterprise Drive
North Quincy, MA 02171-2126
Booth & Co./Annuity Board of 29.21%
Southern Baptist Convention
Post Office Box 92923 C-IN
Chicago, IL 60675-2923
United Airline Pilots 8.27%
50 South LaSalle Street
Chicago, IL 60603-1006
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<PAGE>
Set forth below is a table which contains the name, address and percentage of
ownership of each person who is known by the Fund to own beneficially five
percent or more of the outstanding shares of the Western Asset Limited Duration
Portfolio as of June 30, 1999:
% of Ownership as of
Name and Address June 30, 1999
- ---------------- -------------
Institutional Class
Western Michigan University 73.41%
Investment & Endowment Mgmt.
1083 Seibert Admin. Bldg.
Kalamazoo, MI 49008
Wright State University Foundation 14.54%
Wright State University
Dayton, OH 45435
Good Shephard Medical 12.01%
P.O. Box 160
Westerville, OH 43086
</TABLE>
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<PAGE>
Western Michigan University, Thomson Consumer Electronics Pension Plan
for Employees and the Treasurer of the State of Connecticut may be deemed to
control the Western Asset Limited Duration Portfolio, the Western Asset Core
Plus Portfolio and the Western Asset Non-U.S. Fixed Income Portfolio,
respectively, because each owns more than 25% of the outstanding voting
securities of such Portfolio. The Officers and Directors of the Portfolios own
in the aggregate less than 1% of the outstanding shares of each Portfolio.
PERFORMANCE INFORMATION
Each Portfolio may, from time to time, include its total return in marketing
materials or reports to shareholders or prospective investors. Quotations of
average annual total return for a class of shares of a Portfolio will be
expressed in terms of the average annual compounded rate of return of a
hypothetical investment in that class of shares over periods of one, five and
ten years (up to the life of the class), calculated pursuant to the following
formula: P (1 + T)(exponent n) = ERV (where P = a hypothetical initial payment
of $1,000, T = the average annual total return, n = number of years, and ERV =
the ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the period). All total return figures reflect the deduction of a
proportional share of Portfolio expenses on an annual basis and assume that all
dividends and other distributions are reinvested when paid. The performance of
each class of a Portfolio will differ because each class is subject to different
expenses. The performance figures for the Portfolios shown below represent
performance of the Institutional Class shares, the only class of shares in
existence throughout the relevant periods.
The Western Asset Core Portfolio's total returns as of March 31, 1999 were as
follows:
Average
Cumulative Annual
Total Return Total Return
One Year 5.61% 5.61%
Five Years 45.62% 7.81%
Life of Portfolio(A) 117.06% 9.46%
(A) Portfolio's inception - September 4, 1990.
The Western Asset Intermediate Portfolio's total returns as of March 31, 1999
were as follows:
Average
Cumulative Annual
Total Return Total Return
One Year 6.01% 6.01%
Life of Portfolio(A) 41.70% 7.62%
(A) Portfolio's inception - July 1, 1994.
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<PAGE>
The Western Asset Limited Duration Portfolio's total returns as of
March 31, 1999 were as follows:
Average
Cumulative Annual
Total Return Total Return
One Year 4.96% 4.96%
Life of Portfolio(A) 19.76% 6.37%
(A) Portfolio's inception - May 1, 1996.
The Western Asset Core Plus Portfolio's total returns as of March 31, 1999 were
as follows:
Average
Cumulative Annual
Total Return Total Return
Life of Portfolio(A) 2.58% N/A
(A) Portfolio's inception - July 8, 1998.
The Western Asset Non-U.S. Fixed Income Portfolio's total returns as of March
31, 1999 were as follows:
Average
Cumulative Annual
Total Return Total Return
Life of Portfolio(A) 5.81% N/A
(A) Portfolio's inception - July 15, 1998.
The current annualized yield for the Money Market Portfolios is based upon a
specified seven-day period and is computed by determining the net change in the
value of a hypothetical account in the Portfolio. The net change in the value of
the account includes the value of dividends and of additional shares purchased
with dividends, but does not include realized gains and losses or unrealized
appreciation and depreciation. In addition, the Money Market Portfolios may use
a compound effective annualized yield quotation which is calculated as
prescribed by SEC regulations, by adding one to the base period return
(calculated as prescribed above), raising the sum to a power equal to 365
divided by 7, and subtracting one.
Each Portfolio's performance may fluctuate daily depending upon such factors as
the average maturity of its securities, changes in investments, changes in
interest rates and variations in operating expenses. Therefore, current
performance does not provide a basis for determining future performance. The
fact that a Portfolio's performance will fluctuate and that shareholders'
principal is not guaranteed or insured should be considered in comparing the
Portfolio's performance with the performance of fixed-income investments. In
comparing the performance of a Portfolio to other investment vehicles,
consideration should be given to the investment policies of each, including the
types of investments owned, lengths of maturities of the portfolio, the method
used to compute the performance and whether there are any special charges that
may reduce the yield.
From time to time each Portfolio may compare the performance of a Class of
Shares in advertising and sales literature to the performance of other
investment companies, groups of investment companies or various market indices.
One such market index is the S&P 500, a widely recognized, unmanaged index
composed of the capitalization-weighted average of the prices of 500 of the
largest publicly traded stocks in the U.S. The S&P 500 includes reinvestment of
all dividends.
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<PAGE>
It takes no account of the costs of investing or the tax consequences of
distributions. The Portfolios invest in many securities that are not included in
the S&P 500.
Each Portfolio may also cite rankings and ratings, and compare the return of a
Class of Shares with data published by Lipper Analytical Services, Inc., CDA
Investment Technologies, Inc., Wiesenberger Investment Company Services, Value
Line, Morningstar, and other services or publications that monitor, compare
and/or rank the performance of investment companies. Each Portfolio may also
refer in such materials to mutual fund performance rankings, ratings,
comparisons with funds having similar investment objectives, and other mutual
funds reported in independent periodicals, including, but not limited to,
FINANCIAL WORLD, MONEY MAGAZINE, FORBES, BUSINESS WEEK, BARRON'S, FORTUNE, THE
KIPLINGER LETTERS, THE WALL STREET JOURNAL, AND THE NEW YORK TIMES.
Each Portfolio may compare the investment return of a Class of Shares to the
return on certificates of deposit and other forms of bank deposits, and may
quote from organizations that track the rates offered on such deposits. Bank
deposits are insured by an agency of the federal government up to specified
limits. In contrast, Portfolio shares are not insured, the value of Portfolio
shares may fluctuate, and an investor's shares, when redeemed, may be worth more
or less than the investor originally paid for them. Unlike the interest paid on
many certificates of deposit, which remains at a specified rate for a specified
period of time, the return of each Class of Shares will vary.
Portfolio advertisements may reference the history of Legg Mason and its
affiliates, the education and experience of the portfolio manager, and the fact
that the portfolio manager engages in a particular style of investing (e.g.,
growth or value).
In advertising, each Portfolio may illustrate hypothetical investment plans
designed to help investors meet long-term financial goals, such as saving for a
child's college education or for retirement. Sources such as the Internal
Revenue Service, the Social Security Administration, the Consumer Price Index
and Chase Global Data and Research may supply data concerning interest rates,
college tuitions, the rate of inflation, Social Security benefits, mortality
statistics and other relevant information. Each Portfolio may use other
recognized sources as they become available.
Each Portfolio may use data prepared by Ibbotson Associates of Chicago, Illinois
("Ibbotson") to compare the returns of various capital markets and to show the
value of a hypothetical investment in a capital market. Ibbotson relies on
different indices to calculate the performance of common stocks, corporate and
government bonds and Treasury bills.
Each Portfolio may illustrate and compare the historical volatility of different
portfolio compositions where the performance of stocks is represented by the
performance of an appropriate market index, such as the S&P 500, and the
performance of bonds is represented by a nationally recognized bond index, such
as the Lehman Brothers Long-Term Government Bond Index.
Each Portfolio may also include in advertising biographical information on key
investment and managerial personnel.
Each Portfolio may advertise examples of the potential benefits of periodic
investment plans, such as dollar cost averaging, a long-term investment
technique designed to lower average cost per share. Under such a plan, an
investor invests in a mutual fund at regular intervals a fixed dollar amount
thereby purchasing more shares when prices are low and fewer shares when prices
are high. Although such a plan does not guarantee profit or guard against loss
in declining markets, the average cost per share could be lower than if a fixed
number of shares were purchased at the same intervals. Investors should consider
their ability to purchase shares through low price levels.
Each Portfolio may discuss Legg Mason's tradition of service. Since 1899, Legg
Mason and its affiliated companies have helped investors meet their specific
investment goals and have provided a full spectrum of financial services. Legg
Mason affiliates serve as investment advisers for private accounts and mutual
funds with assets of more than $88 billion as of March 31, 1999.
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In advertising, each Portfolio may discuss the advantages of saving through
tax-deferred retirement plans or accounts, including the advantages and
disadvantages of "rolling over" a distribution from a retirement plan into an
IRA, factors to consider in determining whether you qualify for such a rollover,
and the other options available. These discussions may include graphs or other
illustrations that compare the growth of a hypothetical tax-deferred investment
to the after-tax growth of a taxable investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1790, Boston, Massachusetts 02105,
serves as custodian of the Fund's assets. Boston Financial Data Services, Inc.,
P.O. Box 953, Boston, Massachusetts 02103, serves as transfer and
dividend-disbursing agent and administrator of various shareholder services.
Shareholders who request an historical transcript of their account will be
charged a fee based upon the number of years researched. The Fund reserves the
right, upon 60 days' written notice, to make other charges to investors to cover
administrative costs.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP have been selected to serve as the Fund's independent
accountants. The financial highlights included in the Prospectus and
incorporated by reference into this Statement of Additional Information and the
financial statements incorporated by reference into the Prospectus and this
Statement of Additional Information have been so included and incorporated in
reliance upon the report of PricewaterhouseCoopers LLP, given on their authority
as experts in auditing and accounting.
LEGAL COUNSEL
Ropes & Gray, Boston, MA, serves as legal counsel to the Fund.
FINANCIAL STATEMENTS
The report of independent accountants, financial statements and financial
highlights for the fiscal year ended March 31, 1999 for each of the Western
Asset Limited Duration Portfolio, the Western Asset Intermediate Portfolio, the
Western Asset Core Portfolio, the Western Asset Core Plus Portfolio and the
Western Asset Non-U.S. Fixed Income Portfolio included in the Portfolios' Annual
Reports are hereby incorporated by reference into this Statement of Additional
Information.
The audited Statement of Assets and Liabilities as of March 31, 1999 for the
Western Asset Money Market Portfolio and the Report of Independent Accountants
related thereto, are shown on the following pages.
LM Institutional Fund Advisors I, Inc.
STATEMENT OF ASSETS AND LIABILITIES
March 31, 1999
Money
Market
LM INSTITUTIONAL FUND ADVISORS I, INC.
WESTERN ASSET MONEY MARKET PORTFOLIO
----------
Statement of Assets and Liabilities
March 31, 1999
Cash $ 1,000
Receivable from Western Asset Management Company 31,000
-------
Total assets $32,000
=======
Accrued organization expenses and initial offering costs $31,000
-------
Total liabilities $31,000
=======
Net assets - offering and redemption price of $1.00 per
share with 1,000 shares outstanding (13,100,000,000
shares par value $.001 per share authorized) $ 1,000
=======
------------------------------
Statement of Operations
for the year ended March 31, 1999
Reimbursement by Western Asset Management Company $ 31,000
Expense of organizational costs (31,000)
---------
Net income $ -
=========
Notes to Financial Statements
A. LM Institutional Fund Advisors I, Inc. (the "Corporation"), formerly Western
Asset Trust, Inc. ("Corporation"), was organized on May 16, 1990. The Western
Asset Money Market Portfolio ("Portfolio") constitutes one of the portfolios
established under the Corporation. Western Asset Management Company ("Western
Asset"), a wholly owned subsidiary of Legg Mason, Inc. (a financial services
holding company), has provided the initial capital for the Portfolios by
purchasing 1,000 shares of the Money Market Portfolio at $1.00 per share.
Such shares were acquired for investment and can be disposed of only by
redemption. Legg Mason Wood Walker, Incorporated ("Legg Mason"), a wholly
owned subsidiary of Legg Mason, Inc. and a member of the New York Stock
Exchange, and Arroyo Seco, Inc., a wholly owned subsidiary of Western Asset,
act as distributors of the Portfolios' shares.
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<PAGE>
LM INSTITUTIONAL FUND ADVISORS I, INC.
WESTERN ASSET MONEY MARKET PORTFOLIO, Continued
----------
B. Since the Portfolio had not sold shares to the public as of June 30, 1998,
SOP 98-5 "Reporting on the Costs of Start-up Activities" required the
Portfolio to expense all organizational costs. Western Asset has agreed to
waive payment by the Portfolio for the organization costs paid by Western
Asset.
REPORT OF INDEPENDENT ACCOUNTANTS
----------
To the Shareholder of Western Asset Money
Market Portfolio and the Directors of
LM Institutional Fund Advisors I, Inc.
In our opinion, the accompanying statement of assets and liabilities and the
statement of operations present fairly, in all material respects, the financial
position of Western Asset Money Market Portfolio, hereafter referred to as the
"Fund" (a portfolio of LM Institutional Fund Advisors I, Inc.) at March 31,
1999, and the results of its operations for the year then ended, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Baltimore, Maryland
July 29, 1999
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APPENDIX A
RATINGS OF SECURITIES
Description of Moody's Investors Service, Inc. ("Moody's") corporate bond
- -------------------------------------------------------------------------
ratings:
- --------
Aaa-Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge". Interest payments are protected by a large or exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A-Bonds which are rated A possess many favorable investment attributes and are
to be considered upper- medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa-Bonds which are rated Baa are considered medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba-Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B-Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or maintenance of other
terms of the contract over any long period of time may be small.
Description of Standard & Poor's corporate bond ratings:
AAA-This is the highest rating assigned by Standard & Poor's to an obligation
and indicates an extremely strong capacity to pay principal and interest.
AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to pay
principal and interest is very strong, and in the majority of instances they
differ from AAA issues only in small degree.
A-Bonds rated A have a strong capacity to pay principal and interest, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay principal
and interest. Whereas they normally exhibit adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this category
than for bonds in the A category.
BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominately speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and CC the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposure to adverse
conditions.
A-1
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Description of Moody's preferred stock ratings:
- -----------------------------------------------
aaa-An issue which is rated "aaa" is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stock.
aa-An issue which is rated "aa" is considered a high-grade preferred stock. This
rating indicates that there is a reasonable assurance that earnings and asset
protection will remain relatively well maintained in the foreseeable future.
a-An issue which is rated "a" is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater than in the "aaa"
and "aa" classification, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
baa-An issue which is rated "baa" is considered to be a medium-grade preferred
stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
ba-An issue which is rated "ba" is considered to have speculative elements and
its future cannot be considered well assured. Earnings and asset protection may
be very moderate and not well safeguarded during adverse periods. Uncertainty of
position characterizes preferred stocks in this class.
Description of Moody's Short-Term Debt Ratings
- ----------------------------------------------
Prime-1. Issuers (or supporting institutions) rated Prime-1 (P-1) have a
superior capacity for repayment of short-term promissory obligations. P-1
repayment capacity will normally be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation;
well-established access to a range of financial markets and assured sources of
alternate liquidity.
Prime-2. Issuers (or supporting institutions) rated Prime-2 (P-2) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Description of Standard & Poor's Commercial Paper Ratings
- ---------------------------------------------------------
A. Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2, and 3 to indicate the relative degree of safety.
A-1. This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+) sign
designation.
A-2. Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for the issues
designated "A-1".
A-2
